Merger and Aquation

download Merger and Aquation

of 27

Transcript of Merger and Aquation

  • 8/3/2019 Merger and Aquation

    1/27

    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

  • 8/3/2019 Merger and Aquation

    2/27

    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
  • 8/3/2019 Merger and Aquation

    3/27

    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.

  • 8/3/2019 Merger and Aquation

    4/27

    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

  • 8/3/2019 Merger and Aquation

    5/27

    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.

  • 8/3/2019 Merger and Aquation

    6/27

    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

  • 8/3/2019 Merger and Aquation

    7/27

    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

  • 8/3/2019 Merger and Aquation

    8/27

    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

  • 8/3/2019 Merger and Aquation

    9/27

    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

  • 8/3/2019 Merger and Aquation

    10/27

    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.

  • 8/3/2019 Merger and Aquation

    11/27

    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.

  • 8/3/2019 Merger and Aquation

    12/27

    (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.

  • 8/3/2019 Merger and Aquation

    13/27

    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.

  • 8/3/2019 Merger and Aquation

    14/27

    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

  • 8/3/2019 Merger and Aquation

    15/27

    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.

  • 8/3/2019 Merger and Aquation

    16/27

    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

  • 8/3/2019 Merger and Aquation

    17/27

    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% :-

  • 8/3/2019 Merger and Aquation

    18/27

    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,

  • 8/3/2019 Merger and Aquation

    19/27

    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.

  • 8/3/2019 Merger and Aquation

    20/27

    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

  • 8/3/2019 Merger and Aquation

    21/27

    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

    http://www.investopedia.com/terms/s/synergy.asphttp://www.investopedia.com/terms/s/synergy.asphttp://www.investopedia.com/terms/s/synergy.asphttp://www.investopedia.com/terms/s/synergy.asp
  • 8/3/2019 Merger and Aquation

    22/27

    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

  • 8/3/2019 Merger and Aquation

    23/27

    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

  • 8/3/2019 Merger and Aquation

    24/27

    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

    http://macabacus.com/restructuring/equity-carve-outshttp://macabacus.com/restructuring/equity-carve-outshttp://macabacus.com/restructuring/equity-carve-outshttp://macabacus.com/restructuring/equity-carve-outshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/morris-trustshttp://macabacus.com/restructuring/equity-carve-outshttp://macabacus.com/restructuring/equity-carve-outs
  • 8/3/2019 Merger and Aquation

    25/27

    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
  • 8/3/2019 Merger and Aquation

    26/27

    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.

  • 8/3/2019 Merger and Aquation

    27/27

    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.