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Financial Decision Analysis

Merger and Acquisitions A merger may be regarded as the fusion or absorption of one thing or right into another. A merger has been defined as an arrangement whereby the assets, liabilities and businesses of two or more companies become vested in, or under the control of one company, which may or may not be the original two companies, which has as its shareholders, all or substantially all the shareholders of the two companies. In merger, one of the two existing companies merges its identity into another existing company or one or more existing companies may form a new company and merge their identities into the new company by transferring their business and undertakings including all other assets and liabilities to the new company, known as the merged company. The process of merger is also alternatively referred to as amalgamation. The amalgamating companies loose their identity and the shareholders of the amalgamating companies become shareholders of the amalgamated company. The term amalgamation has not been defined in the Companies Act, 1956. However, the IncomeTax Act, 1961 defines amalgamation as follows: Amalgamation, in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company. The company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company in such a manner that::

all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation;

all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation;

shareholders holding not less than three-fourths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation, and not as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned company;

Types of mergers:
Mergers are generally classified as follows: 1. Cogeneric mergers or mergers within same industries 2. Conglomerate mergers or mergers within different industries 1. Cogeneric mergers These mergers take place between companies within the same industries. On the basis of merger motives, cogeneric mergers may further classified as: (i) Horizontal Mergers (ii) Vertical Mergers Horizontal mergers takes place between companies engaged in the same business activities for profit; i.e., manufacturing or distribution of same types of products or rendering of similar services. A classic instance of horizontal merger is the acquisition of Mobil by Exxon. Typically, horizontal mergers take place between business competitors within an industry, thereby leading to reduction in competition and increase in the scope for economies of scale and elimination of duplicate facilities. The main rationale behind horizontal mergers is achievement of economies of scale. However, horizontal mergers promote monopolistic trend in an industry by inhibiting competition.

Vertical mergers take place between two or more companies which are functionally complementary to each other. For instance, if one company specializes in manufacturing a particular product, and another company specializes in marketing or distribution of this product, a merger of these two companies will be regarded as a vertical merger. The acquiring company may expand through backward integration in the direction of production processes or forward integration in the direction of the ultimate consumer. The merger of Tea Estate Ltd. with Brooke Bond India Ltd. was a case of vertical merger. Vertical mergers too discourage competition in the industry. 2. Conglomerate mergers Conglomerate mergers take place between companies from different industries. The businesses of the merging companies obviously lack commonality in their end products or services and functional economic relationships. A company may achieve inorganic growth through diversification by acquiring companies from different industries. A conglomerate merger is a complex process that requires adequate understanding of industry dynamics across diverse businesses vis--vis the merger motives of the merging entities. Besides the above, mergers may be classified as: Up stream merger, in which a subsidiary company is merged with its parent company. Down stream merger, in which a parent company is merged with its subsidiary company. Reverse merger, in which a company with a sound financial track record amalgamates with a loss making or less profitable company. Acquisitions An acquisition may be only slightly different from a merger. In fact, it may be different in name only. Like mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhanced market visibility. Unlike all mergers, all acquisitions involve one firm purchasing another - there is no exchange of stock or consolidation as a new company. Acquisitions are often congenial, and all parties feel satisfied with the deal. Other times, acquisitions are more hostile. In an acquisition, as in some of the merger deals we discuss above,

a company can buy another company with cash, stock or a combination of the two. Another possibility, which is common in smaller deals, is for one company to acquire all the assets of another company. Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Of course, Company Y becomes merely a shell and will eventually liquidate or enter another area of business. Another type of acquisition is a reverse merger, a deal that enables a private company to get publiclylisted in a relatively short time period. A reverse merger occurs when a private company that has strong prospects and is eager to raise financing buys a publicly-listed shell company, usually one with no business and limited assets. The private company reverse merges into the public company, and together they become an entirely new public corporation with tradable shares. Regardless of their category or structure, all mergers and acquisitions have one common goal: they are all meant to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved.

Distinction between Mergers and Acquisitions Although they are often uttered in the same breath and used as though they were synonymous, the terms merger and acquisition mean slightly different things. When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded. In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created. In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow the acquired firm to proclaim that the action is a merger of equals, even if it's technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the

takeover more palatable. Investopedia.com the resource for investing and personal finance education. A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition. Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders.

Reasons for Mergers and Acquisitions Reasons for M & A

Every merger has its own unique reasons why the combining of two companies is a good business decision. The underlying principle behind mergers and acquisitions ( M & A ) is simple: 2 + 2 = 5. The value of Company A is $ 2 billion and the value of Company B is $ 2 billion, but when we merge the two companies together, we have a total value of $ 5 billion. The joining or merging of the two companies creates additional value which we call "synergy" value.

Synergy value can take three forms: 1. Revenues: By combining the two companies, we will realize higher revenues then if the two companies operate separately. 2. Expenses: By combining the two companies, we will realize lower expenses then if the two companies operate separately. 3. Cost of Capital: By combining the two companies, we will experience a lower overall cost of capital. For the most part, the biggest source of synergy value is lower expenses. Many mergers are driven by the need to cut costs. Cost savings often come from the elimination of redundant services, such as Human Resources, Accounting, Information Technology, etc. However, the best mergers seem to have strategic reasons for the business combination. These strategic reasons include:

1. Positioning - Taking advantage of future opportunities that can be exploited when the two companies are combined. For example, a telecommunications company might improve its position for the future if it were to own a broad band service company. Companies need to position themselves to take advantage of emerging trends in the marketplace. 2. Gap Filling - One company may have a major weakness (such as poor distribution) whereas the other company has some significant strength. By combining the two companies, each company fills-in strategic gaps that are essential for long-term survival. 3. Organizational Competencies - Acquiring human resources and intellectual capital can help improve innovative thinking and development within the company. 4. Broader Market Access - Acquiring a foreign company can give a company quick access to emerging global markets.

Mergers can also be driven by basic business reasons, such as: Bargain Purchase - It may be cheaper to acquire another company then to invest internally. For example, suppose a company is considering expansion of fabrication facilities. Another company has very similar facilities that are idle. It may be cheaper to just acquire the company with the unused facilities then to go out and build new facilities on your own. Diversification - It may be necessary to smooth-out earnings and achieve more consistent long-term growth and profitability. This is particularly true for companies in very mature industries where future growth is unlikely. It should be noted that traditional financial management does not always support diversification through mergers and acquisitions. It is widely held that investors are in the best position to diversify, not the management of companies since managing a steel company is not the same as running a software company. Short Term Growth - Management may be under pressure to turnaround sluggish growth and profitability. Consequently, a merger and acquisition is made to boost poor performance. Undervalued Target - The Target Company may be undervalued and thus, it represents a good investment. Some mergers are executed for "financial" reasons and not strategic

reasons. For example, Kohlberg Kravis & Roberts acquires poor performing companies and replaces the management team in hopes of increasing depressed values.

Process of M & A
The Merger & Acquisition Process can be broken down into five phases:

Phase 1 - Pre Acquisition Review: The first step is to assess your own situation and determine if a merger and acquisition strategy should be implemented. If a company expects difficulty in the future when it comes to maintaining core competencies, market share, return on capital, or other key performance drivers, then a merger and acquisition (M & A) program may be necessary. It is also useful to ascertain if the company is undervalued. If a company fails to protect its valuation, it may find itself the target of a merger. Therefore, the pre-acquisition phase will often include a valuation of the company - Are we undervalued? Would an M & A Program improve our valuations? The primary focus within the Pre Acquisition Review is to determine if growth targets can be achieved internally. If not, an M & A Team should be formed to establish a set of criteria whereby the company can grow through acquisition. A complete rough plan should be developed on how growth will occur through M & A, including responsibilities within the company, how information will be gathered, etc. Phase 2 - Search & Screen Targets: The second phase within the M & A Process is to search for possible takeover candidates. Target companies must fulfill a set of criteria so that the Target Company is a good strategic fit with the acquiring company. For example, the target's drivers of performance should complement the acquiring company. Compatibility and fit should be assessed across a range of criteria - relative size, type of business, capital structure, organizational strengths, core competencies, market channels, etc. It is worth noting that the search and screening process is performed in-house by the Acquiring Company. Reliance on outside investment firms is kept to a minimum since the preliminary stages of M & A must be highly guarded and independent. Phase 3 - Investigate & Value the Target: The third phase of M & A is to perform a more detail analysis of the target company. You want to confirm that the Target Company is truly a good fit with the acquiring company. This will require a more thorough review of operations,

strategies, financials, and other aspects of the Target Company. This detail review is called "due diligence." Specifically, Phase I Due Diligence is initiated once a target company has been selected. The main objective is to identify various synergy values that can be realized through an M & A of the Target Company. Investment Bankers now enter into the M & A process to assist with this evaluation. A key part of due diligence is the valuation of the target company. In the preliminary phases of M & A, we will calculate a total value for the combined company. The calculation can be summarized as follows: Value of Our Company (Acquiring Company) Value of Target Company Value of Synergies per Phase I Due Diligence Less M & A Costs (Legal, Investment Bank, etc.) Total Value of Combined Company $ 560 $ 176 $ 38 -$ 9 $ 765

Phase 4 - Acquire through Negotiation: Now that we have selected our target company, it's time to start the process of negotiating a M & A. We need to develop a negotiation plan based on several key questions: How much resistance will we encounter from the Target Company? What are the benefits of the M & A for the Target Company? What will be our bidding strategy? How much do we offer in the first round of bidding?

The most common approach to acquiring another company is for both companies to reach agreement concerning the M & A; i.e. a negotiated merger will take place. This negotiated arrangement is sometimes called a "bear hug." The negotiated merger or bear hug is the preferred approach to a M & A since having both sides agree to the deal will go a long way to making the M & A work. In cases where resistance is expected from the target, the acquiring firm will acquire a partial interest in the target; sometimes referred to as a "toehold position." This toehold position puts pressure on the target to negotiate without sending the target into panic mode. In cases where the target is expected to strongly fight a takeover attempt, the acquiring company will make a tender offer directly to the shareholders of the target, bypassing the target's management. Tender offers are characterized by the following: The price offered is above the target's prevailing market price.

The offer applies to a substantial, if not all, outstanding shares of stock. The offer is open for a limited period of time. The offer is made to the public shareholders of the target.

A few important points to be remembered: Generally, tender offers are more expensive than negotiated M & A's due to the resistance of target management and the fact that the target is now "in play" and may attract other bidders. Partial offers as well as toehold positions are not as effective as a 100% acquisition of "any and all" outstanding shares. When an acquiring firm makes a 100% offer for the outstanding stock of the target, it is very difficult to turn this type of offer down. Another important element when two companies merge is Phase II Due Diligence. Once we start the negotiation process with the target company, a much more intense level of due diligence (Phase II) will begin. Both companies, assuming we have a negotiated merger, will launch a very detail review to determine if the proposed merger will work. This requires a very detail review of the target company - financials, operations, corporate culture, strategic issues, etc. Phase 5 - Post Merger Integration: If all goes well, the two companies will announce an agreement to merge the two companies. The deal is finalized in a formal merger and acquisition agreement. This leads us to the fifth and final phase within the M & A Process, the integration of the two companies. Every company is different - differences in culture, differences in information systems, differences in strategies, etc. As a result, the Post Merger Integration Phase is the most difficult phase within the M & A Process. Now all of a sudden we have to bring these two companies together and make the whole thing work. This requires extensive planning and design throughout the entire organization. The integration process can take place at three levels: 1. Full: All functional areas (operations, marketing, finance, human resources, etc.) will be merged into one new company. The new company will use the "best practices" between the two companies. 2. Moderate: Certain key functions or processes (such as production) will be merged together. Strategic decisions will be centralized within one company, but day to day operating decisions will remain autonomous.

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3. Minimal: Only selected personnel will be merged together in order to reduce redundancies. Both strategic and operating decisions will remain decentralized and utonomous. Takeover Takeover is a strategy of acquiring control over the management of another company either directly by acquiring shares carrying voting rights or by participating in the management. Where the shares of the company are closely held by a small number of persons a takeover may be effected by agreement within the shareholders. However, where the shares of a company are widely held by the general public, relevant regulatory aspects, including provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997 need to be borne in minds. Takeovers may be broadly classified as follows:

Friendly takeover: It is a takeover effected with the consent of the taken over company. In this case there is an agreement between the managements of the two companies through negotiations and the takeover bid may be with the consent of majority shareholders of the target company. It is also known as negotiated takeover.

Hostile takeover: When an acquirer company does not offer the target company the proposal to acquire its undertaking but silently and unilaterally pursues efforts to gain control against the wishes of the existing management, such acts are considered hostile on the management and thus called hostile takeovers. The takeover of Great Offshore Limited is an example of hostile takeover, where the Bharti Shipyard Limited acquired management control of Great Offshore Limited against the wishes of the Great Offshore promoters.

Bail out takeover: Takeover of a financially weak or a sick company by a profit earning company to bail out the former is known as bail out takeover. Such takeovers normally take place in pursuance to a scheme of rehabilitation approved by the financial institution or the scheduled bank, who have lent money to the sick company. In bail out takeovers, the financial institution appraises the financially weak company, which is a sick industrial company, taking into account its financial viability, the requirement of funds for revival and draws up a rehabilitation package on the principle of protection of interests of

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minority shareholders, good management, effective revival and transparency. The rehabilitation scheme should provide the details of any change in the management and may provide for the acquisition of shares in the financially weak company as follows: 1. An outright purchase of shares or 2. An exchange of shares or 3. A combination of both The acquisition of Satyam Computers by Tech Mahindra is an example of bail out takeover. Joint Venture Joint venture (JV) is a strategic business policy whereby a business enterprise for profit is formed in which two or more parties share responsibilities in an agreed manner, by providing risk capital, technology, patent/trademark/ brand names and access to the market. It is a mode of pooling of resources of the JV partners in order to attain better competencies and efficiencies. JV with multinational companies contribute to the expansion of production capacity, transfer of technology and penetration into the global market. In JVs, the assets are managed jointly. Skills and knowledge flow from both the parties. Leveraged/Management Buyout Leveraged buyout (LBO) is defined as the acquisition of stock or assets by a small group of investors, financed largely by borrowing. The acquisition may be either of all stock or assets of a hitherto public company. The buying group forms a shell company to act as a legal entity for making the acquisition. The LBOs differ from the ordinary acquisitions in two main ways: firstly a large fraction of the purchase price is debt financed and secondly the shares are not traded on open markets. In a typical LBO programme, the acquiring group consists of number of persons or organizations sponsored by buyout specialists. The buyout group may not include the current management of the target company. If the group does so, the buyout may be regarded as Management Buyout (MBO). A MBO is a transaction in

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which the management buys out all or most of the other shareholders. The management may tie up with financial partners and organizes the entire restructuring on its own. An MBO begins with an arrangement of finance. Thereafter an offer to purchase all or nearly all of the shares of a company (not presently held by the management) has to be made which necessitates a public offer and even delisting. Consequent upon this restructuring of the company may be affected and once targets have been achieved, the company can list its share on stock exchange again. Demerger Demerger is a common form of corporate restructuring. In the past we have seen a number of companies following a demerger route to unlock value in their businesses. Demerger has several advantages including the following:

Creating a better value for shareholders by both improving profitability of businesses and changing perception of the investors as to what are the businesses of the Company and what is the future direction;

Improving the resource raising ability of the businesses; Providing better focus to businesses and thereby improve overall profitability; Hedging risk by inviting participation from investors.

Demerger is a court approved process and requires compliance with the provisions of sections 391-394 of the CoAct. It requires approval from the High Courts of the States in which the registered offices of the demerged and resulting companies are located. Under the Act, demerger, in relation to companies, means the transfer, pursuant to a scheme of arrangement, by a demerged company of its one or more undertakings to any resulting company in such a manner that:

all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;

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all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;

the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;

the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;

the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company;

the transfer of the undertaking is on a going concern basis; the demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf.

As evident from the above definition, demerger entails transfer of one or more undertakings of the demerged company to the resulting company and the resultant issue of shares by the resulting company to the shareholders of the demerged company. The satisfaction of the above conditions is necessary to ensure tax neutrality of the demerger. In case of demerger of a listed company of its undertaking, the shares of the resulting company are listed on the stock exchange where the demerged companys shares are traded. For instance, the largest demerger in India was in the case of Reliance Industries wherein its 4 businesses were demerged into separate companies and the resulting companies were listed on the stock exchanges. The shareholders of Reliance Industries were allotted shares in the resulting companies based on a predetermined share swap ratio.

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Slump Sale/Hive off Slump sale is another mode of corporate restructuring, where a company hives off its undertaking. The rationale for hiving off could be diverse viz. hiving off of non-core businesses, selling of its business with a view to raise finances etc. The Act defines slump sale as follows: Slump sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In a slump sale, a company sells or disposes of the whole or substantially the whole of its undertaking for a lump sum pre-determined consideration. i.e. without values being assigned to individual assets and liabilities transferred. The business to be hived off is transferred from the transferor company to an existing or a new company. A Business Transfer Agreement is drafted containing the terms and conditions of business transfer. Legal aspects of M&A Merger/Demerger is a court approved process which requires compliance of provisions under sections 391-394 of the companies act. Accordingly, a merger/demerger scheme is presented to the courts in which, the registered office of the transferor and transferee companies are situated for their approval. However in the case of listed companies such scheme before filing with the State High Court, need to the submitted to Stock Exchange where its shares are listed. The Courts then require the transferor and transferee companies to comply with the provisions of the companies act relating to calling for shareholders and creditors meeting for passing a resolution of merger/ demerger and the resultant issue of shares by the transferee company. The Courts accord their approval to the scheme provided the scheme is not prejudicial to public interest and the interests of the creditors and stakeholders are not jeopardized. The Companies Bill, 2008 was introduced in the Parliament based on J.J. Irani Committee's recommendation and on detailed consultations with various Ministries, Departments and

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Government Regulators. The Bill proposes certain changes to existing provisions with respect to M&A. The key features of the bill as regards M&A are as follows:

Cross border mergers (both ways) seem to be possible under the proposed Bill, with countries as may be notified by Central Government form time to time. (Clause 205 of Companies Bill, 2008) unlike prohibition in case of a foreign transferee company under existing provisions.

Currently merger of a listed transferor company into an unlisted transferee company typically results in listing of shares of the unlisted company. The Bill proposes to give an option to the transferee company to continue as an unlisted company with payment of cash to shareholders of listed transferor company who decide to opt out of the unlisted company.

The Bill proposes a valuation report to be given alongwith notice of meeting and also at the time of filing of application with the National Company Law Tribunal (NCLT) to the shareholders and the creditors which is not required as per the current provisions.

The Bill proposes that in case of merger or hive off, in addition to the notice requirements for shareholders and creditors meetings, confirmation of filing of the scheme with Registrar and supplementary accounting statement where the last audited accounting statement is more than six months old before the first meeting of the Company will be required.

In order to enable fast track and cost efficient merger of small companies, the Bill proposes a separate process for a merger and amalgamation of holding and wholly owned subsidiary companies or between two or more small companies.

The Bill provides that fees paid by the transferor company on authorized share capital shall be available for setoff against the fees payable by the transferee company on its authorized share capital subsequent to the merger. This may enable clubbing of authorized share capital.

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Subsequently, Companies Bill, 2009 was introduced in the Lok Sabha in August 2009 and was referred to the Standing Committee on Finance of the Parliament for examination and report. The SCF has carried out extensive deliberations and interventions on the clauses of the Bill and recommended certain changes in the provisions of the Bill. Some of the key changes of the SCF from M&A perspective are highlighted as under;

Postal ballot for adoption of compromise / arrangement with creditors to be allowed Any compromise or arrangement to be sanctioned only if the accounting treatment, if any, proposed is in accordance with the accounting standards.

The provisions relating to the exit mechanism for investors of a listed company, in case of merger of a listed company with an unlisted company, to be modified to bring reference to regulations made by SEBI for giving a better opt-out or exit mechanism.

Merger and amalgamation of an Indian company with a foreign company or vice versa to require prior approval of RBI.

Economic aspects of M&A Some of the key economic considerations in an M&A process are as follows: Shareholder wealth:An M&A transaction may enhance shareholders value in two ways value creation and value capture. Value creation is a long term phenomenon which results from the synergy generated from a transaction. Value creation may be achieved by way of functional skill or management skill transfers. Value capture is a one time phenomenon, wherein the shareholders of the acquiring company gain the value of the existing shareholders of the acquired company. Synergy: Synergy from mergers and acquisitions has been characteristically connoted by 2+2=5. It signifies improvement of the performance of the acquired company by the strength of the acquiring company or vice versa. There may be operational synergies through improved economies of scale or financial synergies through reduction in cost of capital. Realisation of synergies through consolidation domestic and global have been one of the main aims of the worldwide M&A activities today.

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Market share: The co-relation between increased market share and improved profitability underlies the motive of constant increase of market share by companies. The focus on new markets and increase in product offerings, leads to higher level of production and lower unit costs. Thus this motive is closely aligned with the motive to achieve economies of scale. Core competence: Cogeneric mergers often augment a firms competitiveness in an existing business domain. This urge for core competence is closely aligned with the motive of defending or fortifying a companys business domain and warding off competition. Diversification: The M&A route serves as an effective tool to diversify into new businesses. Increasing returns with set customer base and lower risks of operation form the rationale of such conglomerate mergers. Increased debt capacity: Typically a merged entity would enjoy higher debt capacity because benefits of combination of two or more firms provide greater stability to the earnings level. This is an important consideration for the lenders. Moreover, a higher debt capacity if utilized, would mean greater tax advantage for the merged firm leading to higher value of the firm. Customer pull: Increased customer consciousness about established brands have made it imperative for companies to exploit their customer pull to negotiate better deals fulfilling the twin needs of customer satisfaction and enhancement of shareholder value Valuation aspects of M&A Valuation is the central focus in fundamental analysis, wherein the underlying theme is that the true value of the firm can be related to its financial characteristics, viz. its growth prospects, risk profile and cash flows. In a business valuation exercise, the worth of an enterprise, which is subject to merger or acquisition or demerger, is assessed for quantification of the purchase consideration or the transaction price. Generally, the value of the target from the bidders point of view is the pre-bid standalone value of the target. On the other hand, the target companies may be unduly optimistic in estimating value, especially in case of hostile takeovers, as their objective is to convince the shareholders that the offer price is too low. Since valuation of the target depends on expectations of the timing

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of realization as well as the magnitude of anticipated benefits, the bidder is exposed to valuation risk. The degree of risk depends upon whether the target is a private or public company, whether the bid is hostile or friendly and the due-diligence performed on the target. Taxation aspects of M&A Under the Income-tax Act 1961, a special provision is made which governs the provisions relating to carry forward and set off of accumulated business loss and unabsorbed depreciation allowance in certain cases of amalgamations and demergers. 1. On merger It is to be noted that as unabsorbed losses of the amalgamating company are deemed to be the losses for the previous year in which the amalgamation was effected, the amalgamated company will have the right to carry forward the loss for a period of eight assessment years immediately succeeding the assessment year relevant to the previous year in which the amalgamation was effected. If any of the conditions for allowability of right to carry forward of loss, is violated in any year, the set off of loss or allowance of depreciation made in any previous year in the hands of the amalgamated company shall be deemed to be the income of the amalgamated company chargeable to tax for the year in which the conditions are violated. 2. On Demerger The Income Tax Act provides for movement of accumulated losses and unabsorbed depreciation of the undertaking being demerged in case of a demerger. The manner of ascertaining the accumulated losses and unabsorbed depreciation of the undertaking being demerged is given below: Scenario Where the Method of allocation accumulated Entire amount of directly relatable losses and

business loss and unabsorbed unabsorbed depreciation is allowed to be carried depreciation are directly forward in the hands of the resulting company.

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relatable to the undertaking Where the accumulated The business loss and unabsorbed depreciation

business loss and unabsorbed would be apportioned between the resulting depreciation are not directly company and the demerging company in the ratio of relatable to the undertaking the assets transferred and assets retained.

Human aspects of M&A The top executives involved in implementation of merger often overlook the human aspect of mergers by neglecting the culture shocks facing the merger. Understanding different cultures and where and how to integrate them properly is vital to the success of an acquisition or a merger. Important factors to be taken note of would include the mechanism of corporate control particularly encompassing delegation of power and power of control, responsibility towards management information system, interdivisional and intra-divisional harmony and achieving optimum results through changes and motivation. The key to a successful M&A transaction is an effective integration that is capable of achieving the benefits intended. It is at the integration stage immediately following the closing of the transaction that many well-conceived transactions fail. Although often overlooked in the rush of events that typically precede the closing of the transaction, it is at the integration stage with careful planning and execution that plays an important role which, in the end, is essential to a successful transaction. Integration issues, to the extent possible, should be identified during the due diligence phase, which should comprise both financial and HR exercises, to help to mitigate transaction risk and increase likelihood of integration success. In conclusion, to achieve a flawless M&A transaction lies in being able to start right, well before the combination, plan with precision, and ensure a relentless clarity of purpose and concerted action in the actual integration and post-integration stage.

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Takeover
Meaning In business, a takeover is the purchase of one company by another (the acquirer, or bidder). In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company. Types of takeovers Friendly takeovers A friendly takeover is an acquisition which is approved by the management. Before a bidder makes an offer for another company, it usually first informs the company's board of directors. In an ideal world, if the board feels that accepting the offer serves the shareholders better than rejecting it, it recommends the offer be accepted by the shareholders. In a private company, because the shareholders and the board are usually the same people or closely connected with one another, private acquisitions are usually friendly. If the shareholders agree to sell the company, then the board is usually of the same mind or sufficiently under the orders of the equity shareholders to cooperate with the bidder. This point is not relevant to the UK concept of takeovers, which always involve the acquisition of a public company. Hostile takeovers A hostile takeover allows a suitor to take over a target company whose management is unwilling to agree to a merger or takeover. A takeover is considered hostile if the target company's board rejects the offer, but the bidder continues to pursue it, or the bidder makes the offer directly after having announced its firm intention to make an offer. A hostile takeover can be conducted in several ways. A tender offer can be made where the acquiring company makes a public offer at a fixed price above the current market price. Tender offers in the United States are regulated by the Williams Act. An acquiring company can also engage in a proxy fight, whereby it tries to persuade enough shareholders, usually a simple majority, to replace the management with a new one which will approve the takeover. Another

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method involves quietly purchasing enough stock on the open market, known as a creeping tender offer, to effect a change in management. In all of these ways, management resists the acquisition, but it is carried out anyway. The main consequence of a bid being considered hostile is practical rather than legal. If the board of the target cooperates, the bidder can conduct extensive due diligence into the affairs of the target company, providing the bidder with a comprehensive analysis of the target company's finances. In contrast, a hostile bidder will only have more-limited, publicly-available information about the target company available, rendering the bidder vulnerable to hidden risks regarding the target company's finances. An additional problem is that takeovers often require loans provided by banks in order to service the offer, but banks are often less willing to back a hostile bidder because of the relative lack of target information which is available to them. Reverse takeovers A reverse takeover is a type of takeover where a private company acquires a public company. This is usually done at the instigation of the larger, private company, the purpose being for the private company to effectively float itself while avoiding some of the expense and time involved in a conventional IPO. However, under AIM rules, a reverse take-over is an acquisition or acquisitions in a twelve month period which for an AIM company would:

exceed 100% in any of the class tests; or result in a fundamental change in its business, board or voting control; or in the case of an investing company, depart substantially from the investing strategy stated in its admission document or, where no admission document was produced on admission, depart substantially from the investing strategy stated in its pre-admission announcement or, depart substantially from the investing strategy.

An individual or organization, sometimes known as corporate raider, can purchase a large fraction of the company's stock and, in doing so, get enough votes to replace the board of directors and the CEO. With a new agreeable management team, the stock is a much more attractive investment, which would likely result in a price rise and a profit for the corporate raider and the other shareholders.

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Backflip takeovers A backflip takeover is any sort of takeover in which the acquiring company turns itself into a subsidiary of the purchased company. This type of takeover rarely occurs. Reverse Cowgirl takeovers A reverse cowgirl takeover is a when two companies decide to switch assets and company profiles, while adding assets on top of such a deal in order to even up either company's position. The main advantage to a reverse cowgirl takeover is that neither company suffers the capital gain taxes which a normal cash transaction would involve. The most famous case of a reverse cowgirl takeover was when AOL acquired Netscape in 2000. Although the deal involved minor amounts of cash and stock, the primary commodity exchanged by AOL was free internet service for life to the 478 Netscape employees. However, 3 years later, dial-up service was no longer functioning and instead the United States had shifted towards cable and DSL internet. This caused many former Netscape employees regret for turning down stock and cash in exchange for free internet. Financing a takeover Often a company, acquiring another, pays a specified amount for it. This money can be raised in a number of ways. Although the company may have sufficient funds available in its account, remitting payment entirely from the acquiring company's cash on hand is unusual. More often, it will be borrowed from a bank, or raised by an issue of bonds. Acquisitions financed through debt are known as leveraged buyouts, and the debt will often be moved down onto the balance sheet of the acquired company. The acquired company then has to pay back the debt. This is a technique often used by private equity companies. The debt ratio of financing can go as high as 80% in some cases. In such a case, the acquiring company would only need to raise 20% of the purchase price. Loan note alternatives Cash offers for public companies often include a loan note alternative that allows shareholders to take a part or all of their consideration in loan notes rather than cash. This is done primarily to make the offer more attractive in terms of taxation. A conversion of shares into cash is counted as a disposal that triggers a payment of capital gains tax, whereas if the shares are converted into other securities, such as loan notes, the tax is rolled over.

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All share deals A takeover, particularly a reverse takeover, may be financed by an all share deal. The bidder does not pay money, but instead issues new shares in itself to the shareholders of the company being acquired. In a reverse takeover the shareholders of the company being acquired end up with a majority of the shares in, and so control of, the company making the bid. The company has managerial rights. Takeover Strategies There are a variety of reasons why an acquiring company may wish to purchase another company. Some takeovers are opportunistic - the target company may simply be very reasonably priced for one reason or another and the acquiring company may decide that in the long run, it will end up making money by purchasing the target company. The large holding company Berkshire Hathaway has profited well over time by purchasing many companies opportunistically in this manner. Other takeovers are strategic in that they are thought to have secondary effects beyond the simple effect of the profitability of the target company being added to the acquiring company's profitability. For example, an acquiring company may decide to purchase a company that is profitable and has good distribution capabilities in new areas which the acquiring company can use for its own products as well. A target company might be attractive because it allows the acquiring company to enter a new market without having to take on the risk, time and expense of starting a new division. An acquiring company could decide to take over a competitor not only because the competitor is profitable, but in order to eliminate competition in its field and make it easier, in the long term, to raise prices. Also a takeover could fulfill the belief that the combined company can be more profitable than the two companies would be separately due to a reduction of redundant functions. Takeovers may also benefit from principalagent problems associated with top executive compensation. For example, it is fairly easy for a top executive to reduce the price of his/her company's stock due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance

sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative estimates of future earnings. Such seemingly adverse

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earnings news will be likely to reduce share price. There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates. A reduced share price makes a company an easier takeover target. When the company gets bought out at a dramatically lower price the takeover artist gains a windfall from the former top executive's actions to surreptitiously reduce share price. This can represent tens of billions of dollars transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the fire sale that can sometimes be in the hundreds of millions of dollars for one or two years of work. This is just one example of some of the principal-agent /perverse incentive issues involved with takeovers. Similar issues occur when a publicly held asset or non-profit organization

undergoes privatization. Top executives often reap tremendous monetary benefits when a government owned or non-profit entity is sold to private hands. Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis. This perception can reduce the sale price and make non-profits and governments more likely to sell. It can also contribute to a public perception that private entities are more efficiently run, reinforcing the political will to sell off public assets. Pros and cons of Takeovers While pros and cons of a takeover differ from case to case, there are a few reoccurring ones worth mentioning. Pros: 1. Increase in sales/revenues (e.g. Procter & Gamble takeover of Gillette) 2. Venture into new businesses and markets 3. Profitability of target company 4. Increase market share 5. Decreased competition (from the perspective of the acquiring company) 6. Reduction of overcapacity in the industry 7. Enlarge brand portfolio (e.g. L'Oral's takeover of Body Shop) 8. Increase in economies of scale

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9. Increased efficiency as a result of corporate synergies/redundancies (jobs with overlapping responsibilities can be eliminated, decreasing operating costs) Cons: 1. Goodwill, often paid in excess for the acquisition 2. Culture clashes within the two companies causes employees to be less-efficient or despondent 3. Reduced competition and choice for consumers in oligopoly markets. (Bad for consumers, although this is good for the companies involved in the takeover) 4. Likelihood of job cuts 5. Cultural integration/conflict with new management 6. Hidden liabilities of target entity 7. The monetary cost to the company 8. Lack of motivation for employees in the company being bought. Takeovers also tend to substitute debt for equity. In a sense, any government tax policy of allowing for deduction of interest expenses but not of dividends, has essentially provided a substantial subsidy to takeovers. It can punish more-conservative or prudent management that do not allow their companies to leverage themselves into a high-risk position. High leverage will lead to high profits if circumstances go well, but can lead to catastrophic failure if circumstances do not go favorably. This can create substantial negative externalities for governments, employees, suppliers and other stakeholders.

New Takeover Code

On 23rd September, 2011, the Securities and Exchange Board of India (SEBI) amended the 13 year old takeover rules and notified them with the new set of takeover rules i.e.; the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (commonly referred to as the takeover code) to align it closer to global practices. The main purpose for the new takeover code is also to prevent hostile takeovers and at the same time, provide some more opportunities of exit to innocent shareholders who do not wish to be associated with a particular acquirer.

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Important Definitions (a) Acquirer [Regulation 2(1)(a)] Acquirer means: Any person who, directly or indirectly, acquires or agrees to acquire whether by himself, or through, or with persons acting in concert with him, shares or voting rights in, or control over a target company. It means that any person who enters into an agreement for acquiring the shares in future will also be an acquirer for the purpose of the takeover code. (b) Acquisition [Regulation 2(1)(b)] Acquisition means Directly or indirectly, acquiring or agreeing to acquire Shares or voting rights in, or control over a target company. It means that any agreement entered into between two persons for acquiring the shares in future will also be covered within acquisition for the purpose of the takeover code. (c) Persons acting in concert [Regulation 2(1)(q)] Persons acting in concert means: Persons who, with a common objective or purpose of acquisition of shares or voting rights in, or exercising control over a target company, pursuant to an agreement or understanding, formal or informal, directly or indirectly cooperate for acquisition of shares or voting rights in, or exercise of control over the company. A company, its holding company, subsidiary company and any company under the same management group; Immediate relatives; Promoters and members of the promoter group. (d) Control [Regulation 2(1)(e)] Control includes the right: to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, Including by virtue of their shareholding or management rights or shareholders agreements

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or voting agreements or in any other manner. The concept of control brings such type of persons under the purview of the takeover code that does not hold the shares in their name, but actually control the majority of the directors or control the management or the policy decisions of the company.

Computation of Offer Price [Regulation 8(1)] The takeover regulations govern the computation of offer price because had there been no standard method for computing the offer price, it would have led to the following two types of adverse situations: a. Suppose the market price of the share is R500 and the acquirer offers to buy the shares of the remaining shareholders at just R5 per share, then no one would have would have accepted his offer due to such a low price being offered. Thus, the acquirer would have fulfilled his obligation and ending up with no requirement to buy the shares of other shareholders and that too, completely within the provisions of the law. b. In another case, suppose the market price of the share is R500 and the acquirer offers to buy the shares of the remaining shareholders at a very high price of R2000 per share, then most of the remaining shareholders would have accepted the offer of the acquirer due to such a high price being offered by the acquirer and hence, the acquirer would have easily gained a majority stake in the company and that too, completely within the provisions of the law. This would have meant that hostile takeover can be done by complying with the provisions of law itself. To avoid such type of adverse situations, the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 has prescribed that the offer price shall be the higher of the following: (a) The highest negotiated price per share of the target company for any acquisition under the agreement attracting the obligation to make a public announcement of an open offer; (b) The volume-weighted average price paid or payable for acquisitions, whether by the acquirer or by any person acting in concert with him, during the 52 weeks immediately preceding the date of the public announcement; (c) The highest price paid or payable for any acquisition, whether by the acquirer or by any person acting in concert with him, during the 26 weeks immediately preceding the date of the public announcement;

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(d) The volume-weighted average market price of such shares for a period of 60 trading days immediately preceding the date of the public announcement as traded on the stock exchange where the maximum volume of trading in the shares of the target company are recorded during such period, provided such shares are frequently traded; (e) Where the shares are not frequently traded, the price determined by the acquirer and the manager to the open offer taking into account valuation parameters including, book value, comparable trading multiples, and such other parameters as are customary for valuation of shares of such companies; and (f) The per share value computed under sub-regulation (5), if applicable.

Withdrawal of Offer [Reg.23] A public offer can be withdrawn only in the following circumstances: Some statutory approvals have not been received; or The acquirer, being a natural person, has died; or any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the acquirer, and such agreement is rescinded, subject to such conditions having been specifically disclosed in the detailed public statement and the letter of offer; or such circumstances as in the opinion of the SEBI, merit withdrawal.

Old Takeover Code v/s New Takeover Code

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Rationale behind the New Takeover Code The main rationale behind the new takeover code is to align India's M&A scene to the global practices. The earlier threshold limit of 15% was too early to trigger an open offer considering the fact that a major portion of almost all the listed companies is financed by the Private Equity (PE) firms. The 15% limit meant that the PE firms had to restrict their holding in the company to less than 15% if they didn't want to make an open offer. The new threshold limit of 25% is one at which a potential acquirer can exercise de facto positive control over a company and is able to get a majority of votes in a shareholder's meeting. Also, the Companies Act recognises any holding in excess of 25% as the threshold at which a special resolution can be blocked. The minimum offer size has been increased from 20% to 26%. However, this has been a matter of controversy among many. The twelve member takeover advisory committee had recommended a 100% public offer once the trigger button is pressed as it will give all minority shareholders an opportunity to exit. Even though this proposal appears to be fine in theory, the corporate sector was not in favour of the proposal; and they had their valid reasons. A public offer to all the remaining shareholders would have proven to be very expensive as there would be a lot of financial issues in raising finances for the entire remaining shareholding. The main financial concern is that the RBI doesn't allow banks

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to finance domestic acquisitions; hence a public offer to all the remaining shareholders would have meant that the buyers would have had to raise expensive funds from other sources. Hence, a middle path was chosen and the minimum offer size was increased from 20% to 26%.

Impact of New Takeover Code The new takeover code spells different things to various stakeholders. (a) For retail investors The retail investors should benefit with the removal of the non compete fees as now, the price premium will be distributed over a wider base of shareholders and not just to the promoters. (b) For Institutional investors The Institutional investors, especially the PE firms will now be able to acquire up to 24.99% without triggering an open offer. This also means that the listed companies do not necessarily have to depend only on public markets for capital. (c) For promoters The new takeover code means that the promoters with low holdings should increase their holdings to shield themselves from a potential hostile bid.

Summary Though the new takeover code has increased the threshold limit and the minimum offer size, it is also felt that the RBI should do away with the restriction on banks to fund domestic acquisitions. The SEBI has successfully done one part of the reform process by preparing the new takeover code; the other part requires it successful implementation. To summarise, one may say that the takeover code operates in the following manner:

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