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MF0011 SLM Unit 03 PDF
MF0011 SLM Unit 03 PDF
MF0011 SLM Unit 03 PDF
Unit 3
Unit 3
Structure:
3.1 Introduction
Objectives
3.2 Merger Process
Setting the goals
The Selection criteria and information collection
Evaluation and structuring the offer (term sheet)
Due diligence and documentation
Investment horizon and disposal
Making the decision to sell the business
3.3 Basics Steps in Organising a Merger
3.4 The Five-Stage Model
3.5 Financial Aspects of Mergers
Financial constraints
Surplus cash
Debt capacity
Financing cost
3.6 Merger as a Capital Budgeting Decision
3.7 Summary
3.8 Glossary
3.9 Terminal Questions
3.10 Answers
3.11 Case Study
3.1 Introduction
In the last unit, we studied how corporations typically identify and evaluate
merger opportunities. This is a crucial initiative for the growth of a business,
and the exercise incorporates many strategic thoughts and actions.
In this unit, we take up the other vital aspect of M & A activity the strategic
structuring of a merger or acquisition. The intentions of an acquisition may
be thought out neatly and even documented strongly, but the devil is in the
detail. The success of a merger is probably more because of excellent
implementation than brilliant ideation.
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if the future growth rate can yield the expected return and assess any
potential liabilities by studying the balance sheet.
When you are satisfied with the financial statements and the projections,
you need to work out price of the target acquisition, i.e. do the valuation.
There are a few approaches regularly adopted to determine the valuation of
a business. You can use one of these approaches or a combination. It is
important that you compare your finding with the market capitalisation of
publicly listed companies in a similar sector. Valuation is an art and not a
science, and necessitates application of personal judgement.
After the valuation, you will need to consider the other terms of the offer. All
these will eventually be written into the term sheet. Some other matters that
will be part of the offer include method of paying the consideration, board
representation, percentage shareholding required, management changes
and the administration of major business decisions.
The term sheet forms the basis for negotiation and is the cornerstone of the
legal documents.
3.2.4 Due diligence and documentation
Due diligence process is one common thread that runs throughout much of
the M & A process. Due diligence is the evaluation of the proposed merger
in a detailed and extensive manner. It helps us determine the kind of a fit
that exists between two companies, and whether it is strong enough to
support the merger. This includes the following:
Investment fit: What are the financial resources required, what is the
level of risk of the new organisation, etc.
Strategic fit: What are the management strengths that can be exploited,
to create fresh value? Both the companies in a merger must bring
something unique to the table so that synergy is created.
Marketing fit: How will products and services of the two companies
complement one another? How well do various components of
marketing fit together promotion programmes, brand names, customer
mix, distribution channels, etc.?
Operating fit: How well the different business units and production
facilities are aligned? How operating elements are fitted together
labour force, production capacities, technologies, etc.?
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To expose the major risks related to the proposed merger, due diligence has
to be broad and deep. Some of the risk areas that need to be looked into
are:
Market: How large is the market being targeted? Is it growing? What are
the major threats? Can a merger improve it?
Customer: Who are the customers? Does our business complement the
targeted customers? Can we provide new services or products to these
customers?
Legal: What legal issues are seen in the target company and what more
can we expect from the merger? What is the likely financial impact of
these issues?
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= ` 500 lakh
= ` 250 lakh
= ` 60 lakh
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smooth when both the parties are interested in the merger. This also goes a
long way in making the merger successful.
Step 5: Post-merger integration: On successful conclusion of
negotiations, the two companies announce an agreement to merge, which
leads to the fifth and final phase called integration. This is the most difficult
phase in the M & A process.
Every company has its own distinctive operating style, organisation
structure, culture and strategy. It is the responsibility of the managements of
the two companies to merge these distinctions and get the two companies
stakeholders working in harmony and unison. This requires extensive
planning and step-by-step implementation in the combined organisation.
Only when post-merger integration is successful, the synergies that are the
key objective of the combination can be realised.
Self Assessment Questions
6. The __________ phase is the most difficult phase in the M & A
process.
7. Compatibility and fit should be assessed across a range of criteria
size, kind of business, ___________, core competencies, etc.
8. Due diligence is initiated after the selection of a ___________.
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The authors contention is that the M & A five-stage process model ensures
that the risk involved in value damage are potentially structural in their
foundation, and managing this risk effectively should be crucial while the
acquisition is being considered.
Stage 3: Deal structuring and negotiation
The result of the processes described in Stages 1 and 2 is the specific
target selection. Once the selection has been made by the firm, the merger
transaction has to be negotiated or a takeover bid to be made. The dealmaking takes place in this stage.
The deal structuring and negotiation process is complex and involves many
interconnected steps including:
valuing the target company
choosing experts like investment bankers, lawyers and accountants as
advisors to the deal
obtaining and evaluating maximum intelligence possible about the target
company
performing due diligence
negotiating the senior management positions of the both firms in the
post-merger context
developing the appropriate bid and defence strategies and tactics within
the regulatory and other parameters.
Stage 4: Post-acquisition integration
The objective of this important stage is to make the merged organisation
operational so that the strategic value expectations can be delivered which
drove the merger in the first place.
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the
operations,
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OP = Nx/[Nx + ER (Ny)]
where
Nx = number of outstanding equity shares of acquiring firm X before the
merger.
Ny= number of outstanding equity shares of acquired firm Y before the
merger.
ER = exchange ratio representing the number of shares of firm X
exchanged for every share of firm Y.
Step 6: Calculate NPV of the merger proposal from the point of view of X
as:
NPV (X) = OP [PV (X)] PV (X)
where
NPV (X) = NPV of the merger proposal from the point of view of
shareholders of X
OP = ownership position of the shareholder of firm X
PV (X) = PV of the cash flows of the combined firm X
PV (X) = PV of the cash flows of firm X, before the merger
Illustration 1:
Consider a firm X Ltd.
Step 1: Estimated equity-related post-tax cash flow CF (X)t of X limited is as
follows:
Year
CF (X) t
200
220
236
248
260
CF (X)t
320
360
410
430
450
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After 5 years, cash flow of the combined firm is expected to grow at the
compounded rate of 6% per year.
Step 4: Determination of PV of expected cash flows of the combined firm
PV(X) = 320/1.15 + 360/(1.15)2 + 410/(1.15)3 + 430/(1.15)4 + 450/(1.15)5 +
450(1.06)/[(0.15 0.06) (1.15)5] = 3660.6
3.7 Summary
In tough times, strong companies act to buy other companies and create
a more competitive and cost-efficient company.
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3.8 Glossary
Due diligence: A detailed and extensive evaluation of the proposed merger
Absorption: Full consolidation of the operations, organisation and culture of
both the firms over time.
3.10 Answers
Self
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
Assessment Questions
True.
True.
True.
False.
True.
Post-merger integration.
Capital structure.
Target company.
Process.
Strategic objectives
Sudi Sudarsanam
Competitive positioning.
Empirical.
increases
economies of scale
Core competence.
Cost of acquisition.
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Terminal Questions
1. The merger process includes some basics steps like setting of
objectives, due diligence, deal structuring, etc. For more details, refer
section 3.2.
2. The basics steps of strategic planning are pre-acquisition planning,
searching for target companies to acquire, etc. For more details, refer
section 3.3.
3. To examine the issues that may contribute to the failure of acquisition
and value destruction, a five-stage model of mergers and acquisitions
was developed by the author Sudi Sudarsanam. For more details,
refer section 3.4.
4. There are some key financial aspects of the M & A decision. For more
details, refer section 3.5.
5. The merger is a special type of capital budgeting decision and should
include the effect of operating efficiencies and synergy. It should
therefore be an evaluation of the merged business rather than the
acquired business. For more details, refer section 3.6.
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Refining capacity
While efforts to enhance the refining capacity (of BRPL) were unsuccessful
so far due to non-availability of adequate crude oil in the north-eastern
region, BRPL has recently lined up a ` 2,000-crore investment plan to
increase profitability by upgrading product quality and replacing the existing
production of black oil and naphtha with high-value products.
The company has also stopped operating its polyester staple fibre plant.
The plant was run on naphtha and had turned unviable.
(Source: www.thehindubusinessline.com, circa Jun06)
Question
Make an analysis of the deal between Indian Oil-BRPL.
Hint answer: The deal is likely to be beneficial for both the companies. IOC
is holding 74% stake in BRPL. BRPL has refining capacity of 2.35 million
tonnes of crude and has a net profit of ` 239 crore.
References:
Godbole Prasad G., 2010, Mergers, Acquisitions and Corporate
Restructuring, Vikas Publishing House, New Delhi
Chandra Prasanna, 2007, Financial management, Tata McGraw Hill
Publication, New Delhi
Maheshwari S. N., 2002.Management Accounting, Sultan Chand &
Sons, New Delhi
EReferences:
themanagementor.com
www.som.cranfield.ac.uk
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