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Transcript of Merger and Aquation
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Sub: Mergers Acquisition & Corporate Restructuring
1. (a) Why business fails? Enumerate the symptoms of Business Failure.
Answer) Businesses fail for many reasons. It is important to understand those reasons so thatyou can decide whether or not you are up to the challenge. Those reasons include:
1. FearWhether it is the fear of success or the fear of failure, fear of stepping out ofones comfort zone to try something new, or the fear of trial and error. Fear can freeze aperson dead in his or her tracks.
2. Failure to plan.
3. Lack of funding.
4. Procrastination
5. Excuses. Especially making an excuse for any and everything that causes you tostumble.
6. Doing busy work. Keeping busy doing unimportant tasks.
7. Inability to delegate tasks. Sometimes delegation saves your business. If you have aweakness, hire someone who could turn that weakness into a strength. Use others tocomplete simple time consuming tasks so that you can do other things.
8. Failure to Research.
9. Failure to Market.
10. An inconsistent advertising campaign. It is better to have a ton of small ads on aregular basis than one large ad on a monthly or yearly basis.
11. Your pricing is too low, thus resulting in a negative cash flow.
12. Bad accounting practices.
13. Choosing quantity over quality. Cutting corners is bad business sense.
14. Dishonesty.
15. Not fixing mistakes.
16. Not completing tasks in a timely manner.
17. Inability to follow-up. You should always follow-up by email, snail mail, or phone.
18. Not listening to client or customer. Talking too much.
19. Spending too little. It takes money to make money.
20. Spending too much. Purchasing items when you dont need them, upgrading whenthe older version will do, letting suppliers talk you into things you cannot afford, and notbudgeting.
21. Being unprepared for fluctuations in business. Boom times when demands are highas well as slow times when you are struggling to get by. (Put money away during boom
times to prepare for slow times.)
22. Lack of diversification. If you only offer one product or service, losing it can destroy
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your business.
23. Reputation. While a good reputation will gain you tons of business, a bad reputationcould close your business.
24. Cockiness. There is nothing wrong with feeling great about your products, services,
or accomplishments. Just dont let pride and arrogance destroy your customer relations.
25. Discouragement. Giving in to your feelings of discouragement, when things do notwork out the way you planned or succeed as fast as you thought. Also allowing others tofeed on any discouragement you may already feel.
(b) Explain Altmans Bankruptcy Score.
Answer) The Z-score formula for predicting bankruptcy was published in 1968 byEdward I.
Altman, who was, at the time, an Assistant Professor of Finance atNew York University. The
formula may be used to predict the probability that a firm will go into bankruptcy within two
years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for
the financial distress status of companies in academic studies. The Z-score uses multiple corporate
income and balance sheet values to measure the financial health of a company. The Z-score is a
linear combination of four or five common business ratios, weighted by coefficients. The
coefficients were estimated by identifying a set of firms which had declared bankruptcy and then
collecting amatched sampleof firms which had survived, with matching by industry and
approximate size (assets).Altman applied the statistical method ofdiscriminant analysisto a
dataset of publicly held manufacturers. The estimation was originally based on data from publicly
held manufacturers, but has since been re-estimated based on other datasets for private
manufacturing, non-manufacturing and service companies The Altman Z-Score is a quantitative
balance-sheet method of determining a companys financial health. Safe companies, i.e.
companies that have a low probability of bankruptcy, have an Altman Z-Score greater than 3.0.
TheAltman Z-Scoreis a measure of a companys health and likelihood of bankruptcy. Several
key ratios are used in the formulation of an Altman Z-Score Value.
The Interpretation of Altman Z-Score:
Z-SCORE ABOVE 3.0The company is considered Safe based on the financial figures only.
Z-SCORE BETWEEN 2.7 and 2.99On Alert. This zone is an area where one should Exercise
Caution.
Z-SCORE BETWEEN 1.8 and 2.7Good chance of the company going bankrupt within 2 years
of operations from the date of financial figures given.
Z-SCORE BELOW 1.80- Probability of Financial Catastrophe is Very High.
If the Altman Z-Score is close to or below 3, then it would be as well to do some serious due
diligence
on the company in question before even considering investing.
http://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/wiki/Discriminant_analysishttp://en.wikipedia.org/w/index.php?title=Pair-matched_sample&action=edit&redlink=1http://en.wikipedia.org/wiki/New_York_Universityhttp://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altman -
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2. (a) What are the preliminary steps in Merger?
Answer) PRELIMINARY STEPS IN MERGERS
The process of screening and selecting the right companies for mergers and amalgamations should proceed in a
systematic manner-from general to the more specific. The process starts by identifying the general domains of
potential industries to the specific selection of companies to be evaluated and approached for merger or
acquisition. The process of screening is generally as follows:
1. Identifying Industries
First a set of industries is selected which meet the strategic conditions outlined by the company for the merger.
This may be in terms of size. For instance, a company I wanting to acquire a medium scale investment will
leave out the large investment I industries such as petrochemicals, shipbuilding, etc.
2. Selecting Sectors
Abroad group of acceptable sectors are then identified. For each of these sectors, data with respect to the sales
turnover and growth, return on investment (or sales), market shares, competition and asset turnover etc. is
collected for the various J companies. On the basis of this comparison, the more desirable sectors are chosen.
3. Choosing Companies
Potential companies are carefully looked at with respect to the competitive environment in which they operate.
Specific attention is paid to the competitive strengths of these companies in their sectoral environment.
Comparable sizes are favorable to the chances of success of the merger.
Generally sales turnover and the asset level, which in turn determines the cost level of acquisition, characterize
the size of companies. A common rule of thumb I followed is to consider companies, which are 5 to 10 per cent
in size of the bidding companies.
4. Comparative Cost and Returns
The next step is to consider the financial obligations associated with merger and\amalgamation on the basis of
which the potential companies are reduced further on the basis of their likely return. The companies are listed
and compared with respect to their return on investments and the future expected returns are also developed on
the basis of different market scenarios. The risks and uncertainties are incorporated to ( determine the possible
variations in returns. Finally, the various companies are ranked on the basis of their position against each of the
identified objectives.
prudential requirements and the need for compliance with the various provisions of the statute and approves the
same with or without conditions.
For example, in the case of the application for merger of ICICI Ltd. with ICICI Bank Ltd. submitted to the
Reserve Bank of India (RBI) for regulatory approvals, the Reserve Bank approved the merger subject to certain
conditions.
5. Approvals of Respective High Court(s):
Approval of the respective High Court(s) of both the companies confirming the scheme of amalgamation are
required. The court issues orders for winding up of the amalgamating companies without dissolution on receipt
of the reports from the official liquidator and the Regional Director that the affairs of the amalgamatingcompanies have not been conducted in a manner prejudicial to the interests of its members or to public interest.
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6. Integration Stage:
The structural and cultural aspects of the two organizations, if carefully integrated in the new organization will
lead to the successful merger and ensure that expected benefits of the merger are realized.
(b) Explain various methods of Merger / Amalgamation.
Answer) A merger or amalgamation may be effected by various methods; e.g.,
(i) Merger under a scheme of compromise or arrangement;
(ii) Merger by purchase of shares;
(iii) Merger in public interest under orders of the Central Government;
(iv) Merger through holding company;
(v) Merger by a scheme of winding up; or
(vi) Merger by exchange of shares followed by winding up
3 (a) Explain typical LBO transaction structure.
Answer a) Transaction Structure: An LBO will often have more than one type of debt in order toprocure all therequired financing for the transaction. The capital structure of a typical LBO is
summarized in Table 2 Typical LBO transaction structure.
Offering Percent of Transaction Cost of Capital Lending Parameters Likely Sources
Senior Debt 5060% 710% 57 Years Payback Commercial banks2.0x3.0x EBITDA Credit companies2.0x interest coverage Insurance companies
Mezzanine 2030% 1020% 710 Years Payback Public MarketFinancing 1.02.0x EBITDA Insurance companies
LBO/Mezzanine Funds
Equity 2030% 2540% 46 Year Exit Strategy Management
LBO fundsSubordinated debtHoldersInvestment banks
It is important to recognize that the appropriate transaction structure will vary from company to company andbetween industries. Factors such as the outlook for the companys industry and the economy as a whole,seasonality, expansion rates, market swings and sustainability of operating margins should all be consideredwhen determining the optimal debt capacity for a potential LBO target. For a detailed illustration of themechanics of an LBO transaction, see Exhibit 2, which models a hypothetical buyout scenario.
(b) Explain advantages & disadvantages of LBO.
Identifying
Industries &Select Sectors
Choosing
companies andshort-list good
companies
Assessing
suitability &appropriateness
of timing
Negotiation
stage andobtain
approvals
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Answer) There are a number of advantages to the use of leverage in acquisitions. Large interest andprincipal payments can force management to improve performance and operating efficiency. Thisdiscipline of debt can force management to focus on certain initiatives such as divesting non-corebusinesses, downsizing, cost cutting or investing in technological upgrades that might otherwise bepostponed or rejected outright. In this manner, the use of debt serves not just as a financing technique, butalso as a tool to force changes in managerial behavior.Another advantage of the leverage in LBO financing
is that, as the debt ratio increases, the equity portion of the acquisition financing shrinks to a level at whicha private equity firm can acquire a company by putting up anywhere from 20-40% of the total purchaseprice. Interest payments on debt are tax deductible, while dividend payments on equity are not. Thus, taxshields are created and they have significant value. A firm can increase its value by increasing leverage upto the point where financial risk makes the cost of equity relatively high compared to most companies.Private equity firms typically invest alongside management, encouraging (if not requiring) top executives tocommit a significant portion of their personal net worth to the deal. By requiring the targets managementteam to invest in the acquisition, the private equity firm guarantees that managements incentives will bealigned with their own. The most obvious risk associated with a leveraged buyout is that of financialdistress. Unforeseen events such as recession, litigation, or changes in the regulatory environment can leadto difficulties meeting scheduled interest payments, technical default (the violation of the terms of a debtcovenant) or outright liquidation, usually resulting in equity holders losing their entire investment on a baddeal. The value that a financial buyer hopes to extract from an LBO is closely tied to sales growth rates,
margins and discount rates, as well as proper management of investments in working capital and capitalexpenditures. Weak management at the target company or misalignment of incentives between managementand shareholders can also pose threats to the ultimate success of an LBO. In addition, an increase in fixedcosts from higher interest payments can reduce a leveraged firms ability to weather downturns in thebusiness cycle. Finally, in troubled situations, management teams of highly levered firms can be distractedby dealing with lenders concerned about the companys ability to service debt.
4 (a) Explain in details the types of amalgamations and accounting methods prescribedunder the Accounting Standard 14.
Answer) Types of Amalgamations: amalgamations fall into two broad categories. 1) In the first
category are those amalgamations where there is a genuine poolingnot merely of the assets and liabilities of the
amalgamating companies butalso of the shareholders interests and of the businesses of these companies.Such
amalgamations are amalgamations which are in the nature of mergerand the accounting treatment of such
amalgamations should ensure that the resultant figures of assets, liabilities, capital and reserves more or less
represent the sum of the relevant figures of the amalgamating companies. 2) In the second category are those
amalgamations which are in effect a mode by which one company acquires another company and, as a
consequence, the shareholders of the company which is acquired normally do not continue to have a
proportionate share in the equity of the combined company, or the business of the company which is acquired is
not intended to be continued. Such amalgamations are amalgamations in the nature of purchase. An
amalgamation is classified as an amalgamation in the nature of Some believe that, in addition to an exchange
of equity shares, it is necessary that the shareholders of the transferor company obtain a substantial share in the
transferee company even to the extent that it should not be possible to identify any one party as dominant
therein. This belief is based in part on the view that the exchange of control of one company for an insignificant
share in a larger company does not amount to a mutual sharing of risks and benefits. the substance of an
amalgamation in the nature of merger is evidenced by meeting certain criteria regarding the relationship of the
parties, such as the former independence of the amalgamating companies, the manner of their amalgamation, the
absence of planned transactions that would undermine the effect of the amalgamation, and the continuing
participation by the management of the transferor company in the management of the transferee company after
the amalgamation.
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Methods of Accounting for Amalgamations
There are two main methods of accounting for amalgamations:
(a) the pooling of interests method; and
(b) the purchase method.
(a) The use of the pooling of interests method is confined to circumstances which meet the criteria for an
amalgamation in the nature of merger which satisfies all the following conditions.
(i) All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities
of the transferee company.
(ii) Shareholders holding not less than 90%of the face value of the equity shares of the transferor company
(other than the equity shares already held therein, immediately before the amalgamation, by the transferee
company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue
of the amalgamation. The consideration for the amalgamation receivable by those equity shareholders of the
transferor company who agree to become equity shareholders of the transferee company is discharged by the
transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid
in respect of any fractional shares.
(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the
transferee company.
(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor
company when they are incorporated in the financial statements of the transferee company except to ensure
uniformity of accounting policies.
(b) The object of the purchase method is to account for the amalgamation by applying the same principles as
are applied in the normal purchase of assets. This method is used in accounting for amalgamations in the nature
of Purchase.
(a) The Pooling of Interests Method :- Under the pooling of interests method, the assets, liabilities and
reserves of the transferor company are recorded by the transferee company at their existing carrying amounts If,
at the time of the amalgamation, the transferor and the transferee companies have conflicting accounting
policies, a uniform set of accounting policies is adopted following the amalgamation. The effects on the
financial statements of any changes in accounting policies are reported in accordance
with Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies.3
(b) The Purchase Method :- Under the purchase method, the transferee company accounts for the
amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating
the consideration to individual identifiableassets and liabilities of the transferor company on the basis of their
fairvalues at the date of amalgamation. The identifiable assets and liabilitiesmay include assets and liabilities
not recorded in the financial statements of the transferor company. Where assets and liabilities are restated on
the basis of their fair values, the determination of fair values may be influenced by the intentions of the
transferee company. For example, the transferee company may have a specialized use for an asset, which is not
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available to other potential buyers.The transferee company may intend to effect changes in the activities of the
transferor company which necessitate the creation of specific provisions for the expected costs, e.g. planned
employee termination and plant relocationcosts.
(b)Explain the treatment of goodwill arising on amalgamation.
Answer) Goodwill arising on amalgamation represents a payment made in Anticipation of future
income and it is appropriate to treat it as an asset to be Amortized to income on a systematic basis
over its useful life. Due to the Nature of goodwill, it is frequently difficult to estimate its useful life
with Reasonable certainty. Such estimation is, therefore, made on a prudent basis. Accordingly, it is
considered appropriate to amortize goodwill over a period Not exceeding five years unless a
somewhat longer period can be justified.
Factors which may be considered in estimating the useful life of goodwill arising on amalgamation
include:
The foreseeable life of the business or industry;
The effects of product obsolescence, changes in demand and
Other economic factors;
The service life expectancies of key individuals or groups of
Employees;
expected actions by competitors or potential competitors; and
Legal, regulatory or contractual provisions affecting the useful life.
6.(a) Explain the Leveraged bought Out (LBO) Method of acquisition in reasonable details.
Answer) A leveraged buyout, or LBO, is the acquisition of a company or division of a company with a
substantial portion of borrowed funds. In the 1980s, LBO firms and their professionals were the focus of
considerable attention, not all of it favorable. LBO activity accelerated throughout the 1980s, starting from
a basis of four deals with an aggregate value of $1.7 billion in 1980 and reaching its peak in 1988, when
410 buyouts were completed with an aggregate value of $188 billion. In the years since 1988, downturns in
the business cycle, the near-collapse of the junk bond market, and diminished structural advantages all
contributed to dramatic changes in the LBO market. In addition, LBO fund raising has accelerateddramatically. From 1980 to 1988 LBO funds raised approximately $46 billion from 1988 to 2000, LBO
funds raised over $385 billion. As increasing amounts of capital competed for the same number of deals, it
became increasingly difficult for LBO firms to acquire businesses at attractive prices. In addition, senior
lenders have become increasingly wary of highly levered transactions, forcing LBO firms to contribute
higher levels of equity. In 1988 the average equity contribution to leveraged buyouts was 9.7%. In 2000 the
average equity contribution to leveraged buyouts was almost 38%, and for the first three quarters of 2001
average equity contributions were above 40%. Contributing to this trend was the near halt in enterprise
lending, in stark comparison to the 1990s, when banks were lending at up to 5.0x EBITDA. Because of
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lenders over-exposure to enterprise lending, senior lenders over the past two years are lending strictly
against company asset bases, increasing the amount of equity financial sponsors must invest to complete a
Transaction .These developments have made generating target returns (typically 25 to 30%) much more
difficult for LBO firms. Where once they could rely on leverage to generate returns, LBO firms today are
seeking to build value in acquired companies by improving profitability, pursuing growth including roll-upstrategies (in which an acquired company serves as a platform for additional acquisitions of related
Businesses to achieve critical mass and generate economies of scale), and improving corporate governance
to better align management incentives with those of shareholders.
(b)What are the LBO Candidate criteria?
Answer) LBO Candidate CriteriaGiven the proportion of debt used in financing a transaction, a financial buyers
Interest in an LBO candidate depends on the existence of, or the opportunity to
Improve upon, a number of factors. Specific criteria for a good LBO candidate
Include:
Steady and predictable cash flow
Divestible assets
Clean balance sheet with little debt
Strong management team
Strong, defensible market position
Viable exit strategy
Limited working capital requirements
Synergy opportunities
Minimal future capital requirements
Potential for expense reduction
Heavy asset base for loan collateral
7.Explain the following defense takeover tactics.
1. White Knight
Answer) In a white knight defense, the target company seeks a friendly acquirer for the
business. The target might prefer another acquirer because it believes there is greater
compatibility between the two firms. Another bidder might be sought because that bidder
promises not to break up the target or to dismiss employees en masse. During the 1980s and early
1990s, Hershey Foods had the reputation of acquiring companies at reasonable prices and
transforming the businesses either by enhancing the efficiency of operations or providing a wider
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distribution profile. Hershey was also known for not disrupting the culture of an acquired business
while respecting the traditions acquired. During that period of time, Hershey Foods was called
upon as a white knight on several occasions. None of those potential deals were eventually
consummated. Hershey found that its bid did not reach the level of bid originally offered by the
first bidder. This shortfall may in part be due to the fact that Without the business streamlining
rationalizations enjoyed by the original bidder, Hersheys bid fell short. In those cases,
eventually the money won out. A white squire is similar to a white knight, but the white squire
does not take control of the target firm. Instead, the target sells a block of stock to a white squire
who is considered friendly and who will vote her or his shares with the targets management.
Other stipulations may be imposed, such as requiring the white squire to vote for management, a
standstill agreement that the white squire cannot acquire more of the targets shares for a specified
period of time, and a restriction on the sale of that block of stock. The restriction on the sale of
that block of stock usually includes that the target company has the right of first refusal. The
white squire may receive a discount on the shares, a seat on the targets board, and extraordinary
dividends. Previously, we discussed another board and management defensive tactic of
authorizing preferred equity that is subsequently privately placed with favorable vote. Issuing this
preferred equity to a white squire allows both the target and the white squire to customize the
instrument to the specific needs.
2. Crown Jewel
Answer) A Company may also consider selling its most valuable line of business or division. This
line of business or division is referred to as the
Crown jewels Once this business has been divested, the proceeds can be used to repurchase stock
or to pay an extraordinary dividend. Additionally, once the crown jewels have been divested, the
hostile acquirer may withdraw its bid.
Litigation After a hostile takeover bid has been received, the target company can challenge the
acquisition through litigation. Litigation is initiated by the target company based on the antitrust
effects of the acquisition, inadequate disclosure (missing material information) in SEC filings, orother securities law violations. The target sues for a temporary injunction to prohibit the bidder
From purchasing any additional shares of the targets stock until the court has an
Opportunity to rule on the case.
3. Green Mail
Answer) greenmail is a practice of paying off anyone who acquires a large block of the
companys stock and raises threats ofacquisition. To alleviate those threats, a company can
simply pay that individual a premium over what he or she paid when accumulating the
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companys stock. It is a technique that can be used in a hostile takeover situation. However,
paying greenmail may be counterproductive with less than desired effects, and it could result in
other potential acquirers stepping in to receive their greenmail as well
4. Poison Pill
Answer) A poison pill is a defensive strategy that involves a security with special rights
exercisable by a triggering event. The triggering event could be the announcement of an
acquisition attempt or the accumulation of a certain percentage of stock by another corporation.
Poison pills come in two general varieties that may be used together. The two varieties are flip
over and flip-in plans. A flip-over plan provides for a bargain purchase price of the acquirers
shares; a flip-in program provides a bargain purchase price of the target company.The poison pill,
like the other takeover defenses, must be justified as protection to the corporation and itsshareholders. While a poison pill does not prevent an unwanted takeover, it does strengthen the
boards negotiating position. If a bidder comes in with a substantial offer, the board may redeem
the poison pill. A dead-hand provision allows only the members of the board who initiated the
poison pill to modify or redeem the provision. Once again, the dead-hand provision prevents an
unfriendly acquirer from seizing control of the board and removing the pill. A back-end plan
is a different variety of a poison pill. A back-end plan provides the target shareholders with rights.
At the option of the targets stockholder, a right and a share of the targets stock can be
exchanged for cash or senior debt at a specific price set by the targets board. This effectively
communicates the boards asking price for the company. A poison put takes the form of a bond
with a put option attached. The put option only becomes effective if an unfriendly acquisition
takes place. The bonds are put (or sold back) to the acquiring company, thus putting an additional
drain on the cash requirements of closing the deal. While these forms of poison pills may not
prevent an unfriendly takeover, once again they slow the process, initiate more intense
negotiations, and open the door for more attractive offers. The evidence is very mixed on the
effect of poison pills. Comment and Schwert (1995) found that only early (pre-1985) poison pill
plans were associated with large declines in stockholder value and that takeover premiums were
higher when a target firm had a poison pill in place. Johnson and Meade (1996) studied the topic
by reviewing the market impact of an announcement of a poison pill. They found that the
announcement impact was insignificant whether or not there were other poison pills already in
place. Cook and Easterwood (1994) examined poison puts and concluded that poison puts created
negative returns to shareholders.
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8.(a) What is combination under the Competition Act - 2002.
Answer) COMBINATIONS UNDER COMPETITION ACT: 2002
The provisions relating to combinations have not yet been notified. Broadly, combination includesacquisition of control, shares, voting rights or assets, acquisition of control by a person over anenterprise where such person has control over another enterprise engaged in competingbusinesses, and mergers and amalgamations between or amongst enterprises where these exceedthe thresholds specified in the Act in terms of assets or turnover. If a combination causes or islikely to cause an appreciable adverse effect on competition within the relevant market in India, itis prohibited and can be scrutinized by the Commission.
THRESHOLDS IN CASE OF COMBINATIONS
Combined assets of the enterprises value more than Rs. 1,000 crores or combined turnover ismore than Rs. 3,000 crores. In case either or both of the enterprises have assets/turnover outside
India also, then the combined assets of the enterprises value more than US$ 500 millions,including at least Rs. 500 crores in India, or turnover is more than US$1500 millions, including atleast Rs. 1,500 crores in India .
Combined assets of the group to which the acquired enterprise would belong after combinationbeing more than Rs. 4,000 crores or such group having a joint turnover more than Rs. 12,000crores after acquisition or merger. In case such group has assets/ turnover outside India, then thecombined assets of the group value more than US$ 2 billion, including at least Rs. 500 crores inIndia or turnover is more than US$6 billion including at least Rs. 1,500 crores in India.
Group is defined in the Act. Two enterprises belong to a group if one is in position toexercises at least 26% voting rights or appoint at least 50% of the directors or controls the
management or affairs in the other.
NOTIFICATION TO THE COMMISSION
A firm proposing to enter into a combination, shall notify the Commission in the specified formdisclosing the details of the proposed combination within 30 days of the approval of suchproposal by the board of directors or execution of any agreement or other document.
THE PROCEDURE FOR INVESTIGATION OF COMBINATIONS
If the Commission is of the opinion that a combination is likely to cause or has caused adverseeffect on competition, it shall issue a show cause to the parties as to why investigation in respect
of such combination should not be conducted. On receipt of the response, if Commission is of theprima facie opinion that the combination has or is likely to have appreciable adverse effect oncompetition, it may direct publication of details, inviting objections from the public and hearthem, if considered appropriate. It may invite any person, likely to be affected by thecombination, to file his objections. The Commission may also inquire whether the disclosuremade in the notice is correct and combination is likely to have an adverse effect on competition.
ORDERS THAT COMMISSION CAN PASS IN CASE OF A COMBINATIONThe following orders can be passed by the commission: It shall approve the combination if no appreciable adverse effect on competition is found. It shall disapprove of combination in case of appreciable adverse effect on competition. It may propose suitable modifications.
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(b)Explain any 5 transactions relating to the combination with their Assets andTurnover limits which require a reference to the Competition Commission of India
(CCI).
Answer)
1. All types of intra-group combinations, mergers, demergers, reorganizations and other similar
transactions should be specifically exempted from the notification procedure and appropriate clauses
should be incorporated in sub-regulation 5(2) of the Regulations. These transactions do not have any
competitive impact on the market for assessment under Section 6 of the Competition Act.
2. SEBI Takeover Regulations permit consolidation of shares or voting rights beyond 15% up to
55%, provided the acquirer does not acquire more than 5% of shares or voting rights of the target
company in any financial year. [Regulation 11(1) of the SEBI Takeover Regulations] However,
acquisition of shares or voting rights beyond 26% would apparently attract the notification procedure
under the Act. It should be clarified that notification to CCI will not be required for consolidation of
shares or voting rights permitted under the SEBI Takeover Regulations. Similarly the acquirer whohas already acquired control of a company (say a listed company), after adhering to all requirements
of SEBI Takeover Regulations and also the Act, should be exempted from the Act for further
acquisition of shares or voting rights in the same company.
3. The definition of the term shares should be modified to exclude preference shares within its
purview, as is the case in the SEBI Takeover Regulations. It should also be clarified as to when the
notification procedure should commence in the case of issue of convertible securities or warrants.
4. The draft Regulation 5(2) (x) exempts acquisition of shares or voting rights pursuant to a bonus or
rights issue or sub- division of shares. Drawing the same analogy, cases of consolidation of face valueof shares should also be exempted. The only exception may be a situation where an acquirer acquires
more than its percentage share in a rights issue or a consideration.
5. Conglomerate acquisitions or acquisition of assets by parties not in the same line of business should
be exempted as they are not likely to have an appreciable adverse effect on competition within the
relevant market in India. Since acquisition of control is the crucial factor from competition law
perspective, conglomerate acquisitions must be seen in light of section 5(b) of the Act which covers
acquisition of control in similar, identical or substitutable goods or services.
6. Firm allotments in an IPO should also be exempted from the notification requirement.
7. Acquisitions of shares by promoters from one another or sale by one joint venture partner of its
shares in a joint venture to another joint venture partner should not trigger notification or assessment
under the Competition Act. This is because there is no overall change in the competitive impact of the
joint venture by such a transaction.
8. Further clarification should be provided in respect of the draft Regulation 5(2)(vii) dealing with
renewed tender offer, 5(2)(iii) dealing with international combinations, and 5(2)(xii) dealing with
an acquisition by the Central Government or a State Government.
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9. In Regulation 5(2)(ii), further clarification is required as to the scope of the provision. As currently
drafted, the provision is confusing and appears very limited.
10. The drafting of regulation 5(2), sub-regulation (xiii) is unclear. It excludes any acquisition,
acquiring control, merger or amalgamation, which is specifically exempt under any other statute
made by the Parliament. Firstly, this can easily be held to be ultra-vires the Act which, in fact, hasbeen mandated by the Parliament to have overriding effect on all other laws. Even assuming such a
sweeping exclusion is permissible, it is not clear what exemptions are being referred to here.
9.(a) What is synergy?
Answer) Synergy is ability of merged company to generate higher shareholders wealth than the standalone
entities the nature of synergism is very simple. Synergism exists whenever the value of a combination is greater
than the sum of the values of its parts. In other words, synergism is 2 + 2 = 5, but identifying synergism and
evaluating it may be difficult; in fact, sometimes its implications may be very subtle. As broadly defined to
include any incremental value resulting from business combination. Synergism is the basic economic
justification of merger. The incremental value may derive from increases in either operational or financial
efficiency.
(b)Explain various types of synergies with hypothetical examples.
Answer)
1.Operating Synergism: -
Operating synergism may result from economies of scale, some degree of monophony) power, or increased
managerial efficiency. The value may be achieved by increasing sales volume in relation to assets employed
(operating asset turnover), increasing profit margins, or decreasing operating risk. Although operating synergy
usually is the result of either vertical or horizontal integration, some synergistic effects also may result from
conglomerate growth or the integration of technology and/or personnel into a more deficient unit. In addition,
sometimes a firm may acquire another to obtain patents, copyrights, technical proficiency, marketing skills,
specific fixed assets, customer relationships, or managerial personnel. Operating synergism occurs when these
assets, which are intangible, may be combined with the existing assets and organization of the acquiring firm to
produce an incremental value. Although that value may be difficult to appraise, it may be the primary motive
behind the acquisition.
2. Financial Synergism
As we are broadly interpreting the term, synergism may include financial advantages as well as operating ones.
Among these are incremental values resulting from complementary internal funds flows more efficient use of
financial leverage, increase external financial capability, and income tax advantages.
a. Complementary internal funds flows: Seasonal or cyclical fluctuation in funds flows sometimes may be
reduced or eliminated by merger, if so, financial synergism results in reduction of working capital requirements
of the combination compared to those of the firms standing alone.
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b. More efficient use of financial leverage: Financial synergy may result from more efficient use of financial
leverage. The acquiring firm may have little debt and wish to use the high debit of an acquired firm to lever
earnings of the combination. Or the acquiring form may borrow to finance an acquisition for cash of a low-debt
firm, thus providing additional leverage to the combination. The financial leverage advantage must be weighed
against the increased financial risk.c. Increased External Financial capability: Many mergers, particularly those of relatively small firms into
large ones, occur when the acquired firm simply cannot finance its operations. Typical of this situation is a small
growing firm with expanding financial requirements. The firm has exhausted its bank credit and has virtually no
access to long-term debt or equity markets. Sometimes the small firm has encountered operating difficulty, and
the bank has served notice that its loans will not be renewed. In this type of situation, a large firm with sufficient
cash and credit to finance the requirements of the smaller one probably can obtain a good buy by making a
merger proposal to the small firm. The only alternative the small firm may have is to try to interest two or more
larger firms in proposing merger to introduce completion into their bidding for the acquisition.
The smaller firms situation might not be so bleak. It may not be threatened by nonrenewable of a maturing
loan. But its management may recognize that continued growth to capitalize on its markets will require
financing beyond its means. Although its bargaining position will be better, the financial synergy of the
acquiring firms strong financing capability may provide the impetus for the merger.
Sometimes the financing capability is possessed by the acquired firm. The acquisition of a cash-rich firm whose
operations have matured may provide additional financing to facilitate growth of the acquiring firm. In some
cases, the acquiring firm may be able to recover all or part of the cost of acquiring the cash-rich firm when the
merger is consummated and the cash then belongs to it.
A merger also may be based upon the simple fact that the combination will make two small firms with limited
access to the capital markets large enough to achieve that access on a reasonable basis. The improved financing
capability provides the financial synergy.
Income tax advantages: In some cases, income tax consideration may provide the financial synergy motivating a
merger, for example, assume that firm A has earnings before taxes of about Rs. 10 crore per year and firm B,
now breaking even, has loss carry forward of Rs. 20 crore accumulated from unprofitable operations of previous
years. The merger of A and B will allow the surviving corporation to utilize the loss carry forward, thereby
eliminating income taxes in future periods, as shown in table 1 in effect, such a merger will increase the net
after-tax income of firm A by Rs 4 crore (67 per cent) for each of the next two years. The financial synergism
reflects the fact that the combined firm can use the tax-loss carry forward whereas firm B might never be able to
use it. However, this is permissible under section 72A of Income tax Act relating to merger of only sick
industrial companies of India.
3. COUNTER SYNERGISM
Certain factors may oppose the synergistic effect contemplated from a merger. Often another layer of overhead
costs and bureaucracy is added. Do the advantages outweigh this disadvantage? Sometimes the acquiring firm
agrees to long-term employment contracts with the managers of the acquired firm. Such contracts often are
beneficial but they may be opposite. Personality or policy conflicts may develop that either hamstring operations
or require buying out such contracts to remove personnel from position of authority. Particularly in
conglomerate mergers, management of the acquiring firm simply may not have sufficient knowledge of the
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business to control the acquired firm adequately. Attempts to maintain control may induce resentment by
personnel of the acquired firm. The resulting reduction of efficiency may eliminate expected operating synergy
or even reduce the post merger profitability of the acquired firm. The list of possible counter-synergistic factors
could go on endlessly; the point is that mergers do not always produce the executed results. Negative factors and
the risks related to them also must be considered in appraising a prospective merger.
10. (a) What is the concept of Buy-back of shares? What are the advantages to the
Company undertaking Buy-back.?
Answer)
CONCEPT OF BUYBACK
Buy back of shares is one of the prominent modes of capital restructuring. It is a financial
strategy that allows a company to buy back its equity shares and other specified securities(as
notified by CG) including the securities issued to employees of the Company pursuant to a
scheme of stock option or sweat equity.
Section 77A of the Companies Act,1956 was introduced on 31.10.1998 permitting buyback of
shares when equity is costlier than debt, buy back helps in reducing the overall capital cost.
Buy-back option may help in rectifying the skewed equity share capital in the existing capital
structure of a low 'leveraged' company with stable return.
The advantages to the Company undertaking Buy-back
Increase confidence in management: It might enhance the confidence of its investors on
the companys board of directors, as these investors know that the directors are ever
willing to return surplus cash if its not able to earn above the companys alternative
investment or cost of capital.
Enhances shareholders value: Generally, share buybacks are good for shareholders. The
laws of supply and demand would suggest that with fewer shares on the market, the
share price would tend to rise. Although the company will see a fall in profits because it
will no longer receive interest on the cash, this is more than made up for by the
reduction in the number of shares.
Higher Share Price: Buying back stock means that the company earnings are now split
among fewer shares, meaning higher earnings per share (EPS).Theoretically, higher
earnings per share should command a higher stock price which is great!
Reduce takeover chances: Buying back stock uses up excess cash. There returns on
excess cash in money market accounts can drag down overall company performance.
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Cash rich companies are also very attractive takeover targets. Buying back stock allows
the company to earn a better return on excess cash and keep itself from becoming a
takeover target
Increase ROE: Buying back stock can increase the return on equity (ROE).This effect is
greater the more undervalued the shares are when they are repurchased. If shares are
undervalued, this may be the most profitable course of action for the company.
Psychological Effect: When a company purchases its own stock it is essentially telling
the market that they think that the companys stock is undervalued. This can have a
psychological effect on the market.
Buying back stock allows a company to pass on extra cash to shareholders without
raising the dividend. If the cash is temporary in nature it may prove more beneficial to
pass on value to shareholders through buybacks rather than raising the dividend.
Excellent Tool for Financial Reengineering: In the case of profit making, high
dividend-paying companies whose share prices are languishing, buybacks can actually
boost their bottom lines since dividends attract taxes. A buyback and the subsequent
neutralization of shares, can reduce dividend outflows, and if the opportunity cost of
funds used is lower than the dividend savings, the company can laugh all the way to the
bank.
Tax Implication: Exemption is available only if the shares are sold on recognized stock
exchange and if securities transaction tax (STT) on the sale has been paid. In a buybackscheme, neither does the sale take place on a recognized exchange nor is the STT paid.
So, you will have to pay income tax on your long-term capital gain on the buyback after
deducting the acquisition cost of your shares plus the benefit of indexation from the
year of purchase to the year of buyback. On the resultant gain, the tax would be 20 per
cent plus the applicable surcharge, if any, plus 2 per cent education. You may also work
out the tax at 10 per cent of the gain without considering indexation. Your tax liability
will be limited to the lower of the two calculations.
Stock buybacks also raise the demand for the stock on the open market. This point is
rather self explanatory as the company is competing against other investors to purchase
shares of its own stock
(b)What are the Guidelines in Companies Act 1956 regarding Buy-back?
Answer) SEBI Guidelines: - The Securities and Exchange Board of India (SEBI) has issued
the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee
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Stock Purchase Scheme) Guidelines, 1999, which are applicable to companies whose shares
are listed on any recognized stock exchange in India.
As per the guidelines, no employee stock option scheme (ESOS) shall be offered unless the
company constitutes a compensation committee for administration and superintendence of the
ESOS. The Compensation Committee has to be a committee of the Board of Directors
consisting of a majority of independent directors.
The lock in period and rights of the option holder are as specified in the guidelines.
The Board of Directors have to inter alia, disclose either in the Directors' Report or in the
annexure to the Directors' Report, the details of the ESOS, as specified in the regulations.
As a safeguard the regulations provide that no ESOS can be offered to the employees of a
company unless shareholders of the company approve the ESOS by passing a special
resolution in a general meeting.A company whose shares are listed on a recognized stock
exchange can also issue sweat equity shares in accordance with the provisions of Section 79A
of the Companies Act, 1956 and the Securities and Exchange Board of India (Issue of Sweat
Equity) Regulations, 2002 which were notified on 24th September 2002.
These regulations are not applicable to an unlisted company. However, an unlisted company
coming out with an initial public offering and seeking listing of its securities on the stock
exchange, pursuant to issue of sweat equity shares, is required to comply with the SEBI
(Disclosure and Investor Protection) Guidelines, 2000.
The Sweat Equity Shares are subject to a lock in for a period of three years from the date of
allotment
11. (a) When and under what circumstances the SEBI Takeover Code get triggered?
Answer) The Takeover Code is triggered under the following circumstances:
1. Acquisition of 15% or more of shares or voting right:-
Acquisition of shares to get her with existing holding would entitle acquires to exercise15% or more of voting rights in a target company. He can acquire share after making "Public
announcement".
2. Acquisition by person already holding >15% but 55%:-
Acquisition of shares or voting rights of 5% or more by the person (acquirer/ person
acting concert) Holding more than 15% but less than 55%) of shares or voting rights in a target
company can do after making "Public announcement" This type of acquisition is called creeping
Acquisition.
3. Acquisition by person already holding >55% but 75% :-
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Acquisition of shares or voting rights of by the person (acquirer/person acting concert)
Holding more than 15% but less than 55% but less than 75%o of shares or voting rights in a target
company can do after making "Public announcement" This type of acquisition is called as
consolidation of holding.
4. Acquisition of Control:-
Acquisition of control over a target company with acquisition of shares or voting Rights
control may be of right to appoint directly or indirectly majority of directors on the board of target
company or to control the management or policy decision. By a person or person acting individually
or person acting in concern by virtue of their share holding or management rights or share holder
agreements.
(b)What are the mechanism through which SEBI has attempted to protect the interest
of Shareholders of the Company.
Answer) Capital Issues Control Act was replaced by the Securities and Exchange Board of
India Act, 1992 The SEBI acts as the capital market regulator by acquiring powers from the
Companies Act 1956, the Securities Contracts (Regulation) Act 1956, and from various other
legislations. The SEBI Act has the prime objective of protecting the investors interest. The
SEBI then and there issues guidelines to issuing companies, stock exchanges, stock brokers
and other intermediaries etc., Among other guidelines, the SEBI is of the view that the
guidelines for Disclosure of Information for Investor Protection is expected to protect the
interest of the investors. It is based on the logic that the disclosure of information by the
issuing companies as per the law may enable the investors to take a right investment decision
and there by the investors would protect themselves. If at all, there is any grievance to any of
the investors over the information disclosed or procedure to be followed, the investors can
redress their grievance as per the grievance redressal mechanism of the SEBI. SEBI was, for
quite some time, pressing for comprehensive changes in the SEBI Act. These covered makingcertain capital market offences cognizable and increased monetary penalties for offences; The
proposals were also for granting power to the regulator for search and seizure of books of
intermediaries and other market players, attaching bank accounts and suspension of trading of
scrips, where there were allegations ofmanipulation; SEBI also sought powers, empowering
its officers to summon certain persons dealing with securities like an issuer or an investor
(Gopalsamy, 2005). The rapid growth of economy and globalization of financial markets is
perhaps one of the most significant developments at the international level in the financial
market operations, capital market provides valuable contributions as it deals in financial
assets, excluding coin and currency. The financial assets comprise of banking accounts,
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pension funds, provident funds, mutual funds, insurance policies, shares, debentures, and
other securities. Shares and debentures are playing a very important role in the capital market
operations in the country. The shares and debentures are normally called upon the securities
market. The securities market occupy an important position in the national economy of a
country. It facilitates the mobilization of the savings of individuals and pools them into
reservoir of capital which can be deployed for the economic development of a country.
Efficient stock markets are key to raising of capital by the corporate sector of the economy
and the protection of interest of the investors. In the last decade, far reaching developments
have taken place in the working of the stock market which has influenced the operations of all
the players of the stock market. Present stock market is significantly different from what it
used to be in eighties and before. There appears to be new opportunities, challenges and
threats in the stock market. Among all investment options available, securities are considered
the most challenging as well as rewarding. But investment in securities requires considerable
skill and expertise and carries the risk of loss if the choice of securities is not right or they are
not bought / sold at right time. There are a large variety of instruments referred to as securities
in common parlance. SEBI has been established with the primary objective of protecting the
investors interest in securities, which is defined in the Securities
Contracts [Regulation] Act, 1956 to include:
i. Shares, scrips, stocks, bonds, debenture stock or other marketable securities of a like nature
in or of any incorporated company or body corporate:
ii. Derivative;
iii. Units or any other instrument issued by any collective investment scheme to the investor
in such schemes;
iv. Government Securities;
v. Such other instruments as may be declared by the Central Government to be securities;
vi. Rights or interest in securities.
The Securities and Exchange Board of India (SEBI) has been mandated to protect the
interests of investors in securities and to promote the development of and to regulate the
securities market so as to establish a dynamic and efficient Securities Market contributing to
Indian Economy. SEBI strongly believes that investors are the backbone of the securities
market. They not only determine the level of activity in the securities market but also the level
of activity in the economy.
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SEBI has been created inter alia for the purpose of protecting the interests of investors in
securities. The investor education is more relevant in the context of complexities involved in
various options and instruments of investments available in the securities market. Retail
investors are not in a position to identify and /or appreciate the risk factors associated with
certain scrips or schemes. With the result they are not able to make informed investment
decisions. Since development of securities market largely depends upon proper education of
investors, SEBI is committed to spread awareness amongst them.
The Joint Parliamentary Report (JPC) on securities scam of 2001 had recommended that in
order to enable SEBI to undertake investor education and awareness campaign effectively, the
investor education and protection fund established under section 205C of the Companies Act
and investor education resources of RBI should be shifted to SEBI and a joint campaign for
investor education and awareness under the leadership of SEBI must be undertaken.
The Group noted that majority of the stakeholders have agreed for the setting up of a separate
investor protection fund under the SEBI Act. It is also suggested by the stakeholders that the
said fund should be utilized exclusively for the purpose of investor education, conducting
awareness programme and for protecting the interest of investors.
The Group also noted that the proposed Investor Protection Fund is for the purpose of
achieving the objective of Investor Education and awareness.
In terms of section 55A of the Companies Act, SEBI is required to administer the provisions
of sections specified in section 55A in respect of issue of capital, transfer of securities and
nonpayment of dividend in case of listed companies and the companies which intend to get
their securities listed on the stock exchange. Further, SEBI is required to protect the interest
of investors and enforce redressalfsc of grievances of investors by listed companies.
In the light of the above provisions, the Group also discussed the proposition regarding
payment of compensation to investors for the purpose of investor protection. In this regard,
the Group also deliberated on the suggestion for setting up of a Fund on the lines of Fair Fund
established under the Sarbanes Oxley Act, 2002 of United States which is used for
compensating the investors out of the penalties received. Another view was expressed duringdeliberations that the investors in the equity market invest in risk capital and no assured return
or compensation for non fulfillment of every expectation may be provided in the statute.
However, compensation in respect of fraud or misrepresentations or misstatements by
companies or intermediaries may be considered. Further the Group noted that the Pension
Fund Regulatory and Development Authority, Ordinance, 2004 which mandated the Pension
Fund Regulatory and Development Authority (PFRDA) to protect the interest of subscribers
to the schemes of pension funds has permitted PFRDA to set up the Subscriber Education and
Protection Fund. The said Ordinance also specifies the monies which should be credited to the
said Subscriber Education and Protection Fund. The said Ordinance also provides that all
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sums realized by way of penalties by PFRDA under the Ordinance shall be credited to the
Subscriber Education and Protection Fund.
The Group felt that to achieve the objective of investor protection by investor education and
investor awareness, a separate fund under the SEBI Act on the lines of Subscriber Education
and Protection Fund under PFRDA Ordinance 2004 to be administered by SEBI may be set
up and administered by SEBI for investor education and awareness. Further, the
compensation to small investors in respect of fraud or misrepresentations or misstatements by
companies or intermediaries may be considered as a matter of investor protection out of the
said Investor Protection Fund. In this regard it is felt desirable that SEBI may specify
guidelines and parameters for administration of the Investor Protection Fund the for the
purpose of Investor Education and Awareness and payment of compensation to small
investors. In this regard, the guidelines issued by SEBI in respect of Investor Protection Fund
of stock exchanges may be adopted with necessary changes.
As regards the monies to be credited to the said Investor Protection Fund, the Group took into
consideration the representation of the National Stock Exchange that the big stock exchanges
are utilizing the monies for the purpose suitably. The Group also noted that the monies lying
with the IPF of small stock exchanges are not being utilised to the full satisfaction. It is
considered that the monies lying unutilized for substantial period in the Investor Protection
Fund of the stock exchanges should be transferred to the proposed Investor Protection Fund.
The unclaimed dividend and interest lying with the mutual fund and Collective Investment
Schemes or venture capital funds and the unclaimed monies or securities of the clients lying
with the intermediaries for a period of 7 years should be used in a purposeful manner.
Further, all sums realized by way of penalties imposed by the Adjudicating Officer under
Chapter VIA of the SEBI Act, should be credited to the proposed Investor Protection Fund.
12.Short Notes (Any 4):
1. Synergy in Mergers and Acquisition.
Answer) Synergy, also known as synergism, refers to the combined effects produced
by two or more parts, elements, or individuals. Simply stated, synergy results when
the whole is greater than the sum of the parts. For example, two people can move a
heavy load more easily than the two working individually can each move their half of
the load. The functions ofsynergyallow for the enhanced cost efficiency of a new
entity made from two smaller ones - synergy is the logic behind mergers and
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acquisitions. Synergy can be a positive or negative outcome of combined efforts.
Mergers and acquisitions are corporate-level strategies designed to achieve positive
synergy. The 2004 acquisition of AT&T Wireless by Cingular was an effort to create
customer benefits and growth prospects that neither company could have achieved on
its ownoffering better coverage, improved quality and reliability, and a wide array
of innovative services for consumers. One way to observe synergy in an organization
is to observe the combined efforts of individuals working together. Synergy can result
from the efforts of people serving on committees or teams. By combining their
knowledge, insights, and ideas, groups often make better decisions than would have
been made by the group members acting independently. Positive synergy resulting
from group decisions may well include the generation of more ideas, more creative
solutions, increased acceptance of the decision by group members, and increased
opportunity for the expression of diverse opinions. Much of the current interest in
teams and team building is an effort to achieve positive synergy through the combined
efforts of team members. Negative synergy occurs in groups, committees, and other
joint efforts for a number of reasons. Groups commonly experience negative synergy
because group decisions are often reached more slowly, and thus may be more
expensive to make than individual decisions. The opportunity costs for having a group
of high-paid executives spend an afternoon in a meeting rather than in more
productive endeavors can be quite high. Negative synergy can also occur in group
decisions if an individual is allowed to dominate and control the group decision. Also,
groupthinkthe pressure to conformmay cause the group to strive for harmony
instead of evaluating information and alternative courses of action honestly and
objectively
2. Friendly Takeover.
Answer) The acquisition of a target company that is willing to be taken over. Usually, the target
will accommodate overtures and provide access to confidential information to facilitate the
scoping and due diligence processes.
The Friendly Takeover Process
1. Normally starts when the target voluntarily puts itself into play.
Target uses an investment bank to prepare an offering memorandum
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May set up a data room and use confidentiality agreements to permit
access to interest parties practicing due diligence
A signed letter of intent signals the willingness of the parties to move
to the next step(usually includes a no-shop clause and a
termination or break fee)
Legal team checks documents, accounting team may seek advance
tax ruling from CRA
Final sale may require negotiations over the structure of the deal
including:
Tax planning
Legal structures
2. Can be initiated by a friendly overture by an acquisition seeking information that will assist in
the valuation process.
In friendly takeovers, both parties have the opportunity to structure the deal to their mutual
satisfaction including:
1. Taxation Issuescash for share purchases trigger capital gains so share
exchanges may be a viable alternative
2. Asset purchases rather share purchases that may:
Give the target firm cash to retire debt and restructure financing
Acquiring firm will have a new asset base to maximize CCA
deductions
Permit escape from some contingent liabilities (usually excluding
claims resulting from environmental lawsuits and control orders that
cannot severed from the assets involved)
3. Earn outs where there is an agreement for an initial purchase price with
conditional later payments depending on the performance of the target after
acquisition.
3. Spin-off.
Answer) Spin-Offs
In a spin-off, the parent company (Parent Co) distributes to its existing shareholders new
shares in a subsidiary, thereby creating a separate legal entity with its own management team
and board of directors. The distribution is conducted pro-rata, such that each existing
shareholder receives stock of the subsidiary in proportion to the amount of parent company
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stock already held. No cash changes hands, and the shareholders of the original parent
company become the shareholders of the newly spun company (Spin Co).
there are four ways to execute a spin-off:
Regular spin-offCompleted all at once in a 100% distribution to shareholders
Majority spin-offParent retains a minority interest (< 20%) in SpinCo and distributes the
majority of the SpinCo stock to shareholders
Equity carve out (IPO) / spin-offImplemented as a second step following an earlierequity
carve-outof less than 20% of the voting control of the subsidiary
Reverse Morris TrustImplemented as a first step immediately preceding aReverse Morris
Trusttransaction
Parent Cos existing credit agreements may impose restrictions on divestitures that are
material in nature. It is important to determine if any credit terms will be violated if ParentCo
spins off a subsidiary that materially contributes to its business.
The separate business entities created in a spin-off sometimes differ in many ways from the
consolidated company, and may no longer be suitable investments for some original
shareholders. Spun-off companies are often much smaller than their original parents, and are
frequently characterized by higher growth. Institutional investors committed to specific
investment styles (e.g. value, growth, large-cap, etc.) or subject to certain fiduciary
restrictions may need to realign their holdings with their investment objectives following a
spin-off by one of their portfolio companies. For example, index funds would be forced to
indiscriminately sell SpinCo stock if SpinCo is not included in the particular index.
As institutional investors "rotate out" of, or sell, their parent and/or new subsidiary stock, the
stocks may face short-term downward pricing pressure lasting weeks or even months until the
shareholder bases reach new equilibriums. Shareholder churn and the corresponding potential
for short-term pricing pressure can affect timing of a spin-off when CEOs are sensitive to
stock price performance.
On the other hand, spin-offs are commonly executed in response to shareholder pressure to
divest a subsidiary, perhaps because the hypothetical sum-of-the-parts valuation exceeds thecurrent value of the consolidated enterprise. In these cases, the parent and/or new subsidiary
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stock may experience upwardpricing pressure following a spin-off that mitigates downward
pressure due to shareholder rotation. In the long run, stocks of the individual companies
should theoretically trade higher in aggregate than stock of the consolidated company when
the spin-off is well-received by investors.
Also, when SpinCo is highly levered as a result of debt pushdown or loans incurred prior to
spin-off, shareholder returns receive a boost when SpinCo generates returns in excess of its
cost of capital. The effect is identical to how the use of leverage in LBO transactions
magnifies returns to financial buyers
4. Pension Parachute.
Answer ) Parachutes are employee severance agreements that are triggered when a change in
control takes place. The purpose is to provide the corporations managers and employees with
peace of mind during acquisition discussions and the transition. It helps the corporation retain key
employees who may feel threatened by a potential acquisition. Parachutes also help the manager
to address personal concerns while acting in the best interest of the stockholder. The current board
and management team establish the parachutes that become effective when a potential acquirer
exceeds a specified percentage of ownership in the company. Parachutes may be put in place
without the approval of stockholders and may be rescinded in the case of a friendly takeover.
A pension parachute is a form ofpoison pillthat prevents the raiding firm of a hostiletakeover
from utilizing the pensionassetsto finance the acquisition. When the targetfirmis threatened by
an acquirer, the pension plan assets are only available to benefit the pension plan participants.In
corporate governance, the pension parachute protects the surplus cash in the pension fund of the
target from unfriendly acquirers; the funds remain the property of the plans participants in the
target company. The law firm ofKelley Drye & Warrenclaims to be the pioneers of the "pension
parachute". Their first pension parachute was implemented forUnion Carbide, and its design was
upheld in Union Carbides litigation with GAF. Parachutes come in three varieties. First, thegolden parachute is designed for the corporations most senior management team, say, the top 10
to 30 managers. Under this type of plan, a substantial lump-sum payment (maybe multiples of the
managers annual salary and bonus) is paid to a manager who is terminated following an
acquisition. A silver parachute widens the protection to a much larger number of employees and
may include middle managers. The terms of a silver parachute often cover severance equal to 6
months or 1 year of salary. Finally, a tin parachute may be implemented that covers an even wider
circle of employees or even all employees. This program provides limited severance pay and may
be structured as severance pay equal to 1 or 2 weeks of pay for every year of service
http://en.wikipedia.org/wiki/Poison_pillhttp://en.wikipedia.org/wiki/Poison_pillhttp://en.wikipedia.org/wiki/Poison_pillhttp://en.wikipedia.org/wiki/Takeoverhttp://en.wikipedia.org/wiki/Takeoverhttp://en.wikipedia.org/wiki/Takeoverhttp://en.wikipedia.org/wiki/Assetshttp://en.wikipedia.org/wiki/Assetshttp://en.wikipedia.org/wiki/Assetshttp://en.wikipedia.org/wiki/Company_%28law%29http://en.wikipedia.org/wiki/Company_%28law%29http://en.wikipedia.org/wiki/Company_%28law%29http://en.wikipedia.org/wiki/Kelley_Drye_%26_Warrenhttp://en.wikipedia.org/wiki/Kelley_Drye_%26_Warrenhttp://en.wikipedia.org/wiki/Kelley_Drye_%26_Warrenhttp://en.wikipedia.org/wiki/Union_Carbidehttp://en.wikipedia.org/wiki/Union_Carbidehttp://en.wikipedia.org/wiki/Union_Carbidehttp://en.wikipedia.org/wiki/Union_Carbidehttp://en.wikipedia.org/wiki/Kelley_Drye_%26_Warrenhttp://en.wikipedia.org/wiki/Company_%28law%29http://en.wikipedia.org/wiki/Assetshttp://en.wikipedia.org/wiki/Takeoverhttp://en.wikipedia.org/wiki/Poison_pill -
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5. Vertical Integration.
Answer) Vertical mergers occur between firms in different stages of production operation. In a vertical merger
two or more companies which are complementary to each other e.g. one of companies is engaged in the
manufacture of a particular product and the other is established and expert in the marketing of that product or is
engaged in production of raw material or ancillary items used by the other company in manufacturing or
assembling the final and finished product join together. In this merger the two companies merge and control the
production and marketing of the same product. Vertical merger may take the form of forward or backward
merger. When a company combines with the supplier of material, it is called a backward merger and where it
combines with the customer, it is known as forward merger. A vertical merger may result into a smooth and
efficient flow of production and distribution of a particular product and reduction in handling and inventory
costs. It may also pose a risk of monopolistic trend in the industry. As a whole the efficiency and affirmative
rationale of vertical integration rests primarily on costliness of market exchange and contracting.
6. Exempted Acquisitions under Takeover Code.
Answer) 1. Acquisition arising out of firm allotment in public issue
2. Right issue
3. Allotment to the underwriter pursuant to the underwriting Agreement
4. Inter-se transfer amongst group companies , relatives , promoter ,acquirer and PACs , Indian
promoter and foreign collaborator
5. Acquisition of Share in the ordinary course of business by :-
STOCK BROKERS ON BEHALF OF CLIENTS
MARKET MAKERS
PUBLIC FINANCIAL INSTITUTIONS ON THEIR OWN ACCOUNT
BY BANKS AND PUBLIC FINANCIAL INSTITUTION AS PLEDGEE
IFC, ADB, IBRD, COMMONWEALTH DEVELOPMENT CORPORATION AND SUCH
OTHER INTERNATIONAL FINANCIAL INSTITUTIONS
SAFETY NET OFFER BY PROMOTERS OF THE COMPANY AND MERCHANT
BANKERS.
7. Mezzanine financing in LBO.
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Answer) Mezzanine Financing is so named because it exists in the middle of the capital structure
and generally fills the gap between bank debt and the equity in a transaction. Mezzanine financing
is junior to the bank debt incurred in financing the leveraged buyout and can take the form of
subordinated notes from the private placement market or high-yield bonds from the public
markets, depending on the size and attractiveness of the deal. Mezzanine financing is
compensated for its lower priority and higher level of risk with higher interest rates, either cash,
paid-in-kind (PIK) or both, and, at times, warrants to purchase typically 2% to 5% of the pro
forma companys common equity. Each tranche of debt financing will likely have different
maturities and repayment terms. For example, some sources of financing require mandatory
amortization of principal in addition to scheduled interest payments. There are a number of ways
private equity firms can adjust the targets capital structure. The ability to be creative in
structuring and financing a leveraged buyout allows private equity firms to adjust to changing
market conditions.