Ma

Major Examination
Merger and Acquisition
MSL 806

Name: Neha Gupta

Entry Number: 2019SMZ8740
Serial Number: 5
Q1. a) As the Chief Strategy Officer of your company, what growth strategies will you suggest
HDFC Bank Limited? Use the concepts taught in the class to answer this question. Give your
answer with justification.

The entire Indian banking industry is witnessing a paradigm shift in systems, processes,
strategies, necessitating the need for the creation of new competencies and capabilities on an on-
going basis. We believe that for banks to capitalize fully on growth opportunities available in the
present global environment, apart from having a research-driven organizations, we must also
have vision; We must consider the possibilities of making the bank "more than a bank".

MARKETS
Existing New
Existing

Marketing Product
Penetrating Development
PRODUCTS

Market
New

Diversification
Development

The growth strategies available for the HDFC banks are:

1. Market Penetration: It includes accelerating the efficiency/effectiveness of marketing
effort, enhancing/modifying existing services resulting in increasing the number of
customers, number of services used by the existing customers, increase in the size of
average account and decrease in the count of lost customers.
2. Market Development: This strategy focus on increase in the number of customer groups
in new markets requiring some form of regional, national, or international market
expansion. It is developing new market for present services.

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 3. Product Development: It involves developing new products and service offering for
existing markets. This is an expansion of product range within the present customers. The
possibility range from major modifications of present services to technologically
innovative services.
4. Diversification: It includes new products and services for new markets. Diversification
involves pursuing newness outside the mainstream of the present businesses — in effect,
starting new businesses since both products and markets are new. The new products may
be technologically related to present offerings or unrelated but in either case they are
independent of the current product mix.
The above strategies explains the broader perspective to grow. Alternatively, some other
strategies available are:
 Acquiring other banks and financial institution as a way of horizontal merger, that
will help in achieving revenue and cost synergies. In 2008, HDFC Bank merged with
Centurion Bank of Punjab. It was the 7th largest merger ever and attain growth at in
the strategic level in terms of size and customer base and achieving higher credit
creation capacity.
 Growth through congeneric merger, wherein a bank can acquire a leasing company or
an insurance company, for example, Axis Bank is increasing stake in Max Life
General Insurance. It facilitates cross selling and up selling with the current customer
base, which will help in generating more revenues.
 Diversifying into new segments by acquiring companies offering entirely different
range of product offering that helps to diversify risk existing in current business and
creating a balanced portfolio (Conglomerate merger). Like when a bank acquire
entirely different business, say an automobile company.
 Expanding and diversifying in international markets by adopting different routes to
expand in global market. For starters may be through a joint venture/ strategic
alliance with the international bank player.
 Product innovation by timely introduction of new and better products offered by
competitors.
 Adopting altogether new business model, by working on design from the base and
revamping the entire customer service and satisfaction to foster long term relationship

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 with the customers. The bank should focus on moving from core traditional core
ecosystem to banking adjacencies like providing services like accounts receivable
management, factoring, cash flow analysis to SMEs.
 With the world going digital, increasing efficiency and effectiveness of current
platform through upscaling current technology by employing artificial intelligence,
new analytics capabilities, enhanced security, expansion of IT infrastructure etc.
There by providing customers with easy, one stop access to financial products and
address multiple financial needs through a common integrated channel.
 Extending value across the customer journey, by engaging with consumers at other
stages of their decision journey. For example, a bank might give advice to customers
on how much to save for retirement or borrow for a home, or help them to determine
the best rates and maturities for financial instruments.
With the above growth strategies in mind, and with the changing demand of consumers requiring
seamless, uninterrupted and trusted branchless banking, mobile banking and over all digital
present. The new normal is going digital.

b. Assume that you propose inorganic growth route for your company in the form of M&A.
Identify the potential target company with which your company should merger/ acquire, giving
suitable justification for the choice of mode. Use appropriate financial valuation methods to
evaluate the deal. Prepare a football field for the deal. Make suitable assumptions where ever
required. You can copy paste the workings neatly for reference in the answer sheet.

“Inspirisys Solutions Limited” has been identified as a one stop solution for all the digital
enhancement needs due to enhanced internet traffic. The company operates as an information
technology services and consulting company in India and internationally based in Chennai. It
offers solution for enterprise security and risk services, cloud computing, internet of things,
infrastructure and product engineering and development services. The acquisition of the
company will offer HDFC Bank following benefits:
 The adoption of data analytics and emergent technologies such as Artificial Intelligence
and Machine Learning would facilitate implementation of enhanced customer experience

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 through automated bots for queries, mail handler, recommender system, internet of
things, mobile money management etc. This will help to increase operational efficiencies.
 Multi-tier security system as a defense mechanism against cyber threats and risk
management. This will increase customer trust and commitment towards our products
offering.
 Providing instant cloud based solutions and services through remote infrastructure
management, given the expansion of digital transaction, the cloud management is the
need of an hour. It will not only reduce cost, but gain agility with sustained and rapid
changes, and ultimately help in digital transformation.
 International presence through cross selling financial services to the existing customer
base of Inspirisys in United Kingdom, Japan, USA, UAE and Singapore.
The cost of acquisition and the evaluation of the inorganic acquisition of “Inspirisys Solutions
Limited” is done using Net Present Value method.
Step 1: Calculation of Cost of Acquisition:
Cost of Acquisition Amount (INR)
     
  Payment to existing shareholders 1,069,655,571
Add Market Value of Debt 2,101,100,000
     
Less Cash and Equivalents 122,200,000
     
    3,048,555,571

Step 2: Determining the Incremental free cash flows

An alternative way to calculate the cash from is to Amount
extract data from cash flow statement:XParticulars (INR)
     
473,800,00
  Cash Flow from Operating Activities
0
   
111,200,00
Add Interest Expenses
0
Less Tax Shield on Interest Expense (21.55%) 23,963,600
Less Capital Expenditure 48,000,000
     
  Free Cash Flow 513,036,40

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 0

Step 3: Determination of appropriate discount rate.

Discount rate (WACC) is assumed to be 10%

Step 4: Determination of present value of FCFF

Given the digital transformation due to COVID pandemic, the IT sector is expected to grow at a
higher pace in comparison to other sectors. First 6 years free cash flow are likely to grow at 11%
and after five years at a constant rate of 8%.
Free Cash Growth rate Discount rate Present Value of
XYear
Flow (11%) (12%) FCF
569,470,404.0
2021 11% 0.893 508,537,070.77
0
632,112,148.4
2022 11% 0.797 503,793,382.31
4
701,644,484.7
2023 11% 0.712 499,570,873.16
7
778,825,378.0
2024 11% 0.636 495,332,940.47
9
864,496,169.6
2025 11% 0.567 490,169,328.21
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    Sum of PV of FCF 2,497,403,594.91

Step 5: Determination of Terminal Value

Terminal Value = Free Cash Flow (2026)* (1+ g%)
Ko% – g%
= 2,497,403,594.91* 1.08 / 12% - 8%
= 1,323,457,186.17
Present Value of Terminal Value (2026) = 1,323,457,186.17 * 0.567
= INR 750,400,224.56
Step 6: Determination of Net
Present ValueXNet Present Value Amount
2,497,403,594.9
  PV of FCFF(years 1-5) 1
PV of FCFF(subsequent to
  year 5) 750,400,224.56

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 3,247,803,819.4
  Total PV of benefits 7
     
Less Cost of acquisition 3,048,555,571
     
      199,248,248.47

Thus the Net Present Value of the acquisition is INR 199.24 million, the proposal is financially
feasible.

Mode of Financing: Since the acquirer is a bank and also for the financial year 2019 – 2020, the
bank Profit after Tax is INR 262,570 million. With the sufficient availability of earning, it make
sense to acquire the company through all cash transaction instead of issuing shares to prevent
loss of ownership of the bank.

Football Field for the transaction:

Equity Value Per Share   Min Max Diff
Methods 2018 2019 2020 P/E 24.52 42.60 18.08
P/E 24.52 34.20 42.60 EV/EBITDA 8.1 14.65 6.55
EV/EBITDA 14.65 13.72 8.1 P/BV 3.60 6.49 2.89
P/BV 3.60 6.49 3.83 EV/Total Revenue 0.35 0.74 0.39
EV/Total
EV/EBIT 9.41 25.39 15.98
Revenue 0.67 0.74 0.35
EV/EBIT 25.39 17.08 9.41 52 week range 17 55.00 38.00

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 Football Field Chart
52 week 17

EV/EBIT 9.41

EV/Total Revenue 0.35

P/BV 3.6

EV/EBITDA 8.1

P/E 24.52

0 10 20 30 40 50 60 70

The above football field chart gives the graphical summary relating to the range of the potential
value of the target, computed through different valuation methods. The dashed line between 20
and 30 is the current share price of the company i.e. 27.

c) What kind of corporate governance hurdles should be taken care of while planning and
executing this deal?

Corporate Governance is the defined as a set of processes, polices, customs, laws and institutions
affecting the way the organization is directed, administered and controlled. Corporate
governance aims to reduce or eliminate the agent-principle problem inherent in a corporation,
thus helping to achieve the goal of a firm, that is, maximization of shareholders wealth.
However, complexity, size, diffuse ownership, conflicting interest of owners and agents, and
moral hazard can impact good governance. Therefore, an effective and appropriate board
structure acts as a mitigating factor with regards to minimizing the agency problem, with the aim
of improving corporate performance and maximizing long-term shareholder value.

As proposed by Basel committee, CG for banking organizations is arguably of greater

importance than for other corporations, given the crucial financial intermediation role of banks in
economy and is essential to achieving and maintaining the public trust and confidence in the
banking system.

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1. Constitution of Board: According to researchers, the greater the number of directors, the
greater is the possibility of failing M&A. coordination and communication between the
BOD and top management of the company is mainly dependent on the size of the board
and the concentration of ownership in the top management. Therefore, the differences
between the interests of the shareholders with a large board of directors may reduce the
effectiveness of taking strategic decisions including M&A.
2. CEO Duality: There should be the separation of the post of CEO and chairman of the
board of directors in the company and have positive impact on the merger/acquisition. If
the person is same, there is a conflict of interest, because Chairman represents top
management and CEO represents BOD, the object of both the party being different.
3. Ownership Concentration: If the shares of a company are concentrated in few hands, it
gives more discretionary power to the management in making the acquisition decision.
The reason is that it is easy and less costly to coordinate few shareholders rather than
numerous minor shareholders with different preference structures.
4. Board Diversity: There may be difference in the opinion of executing the merger because
of the gender, age and nationality diversity.
5. Accountability issues: Effective corporate governance necessitates accountability. From
the top-level executives to lower-tier employees, each level and division of the
corporation should report and be accountable to another as a system of checks and
balances. Also actions of management of the organization is accountable to the
shareholders and public at large.
6. Transparency: Timely disclosures and fair presentation of information as much for
compliance as for stakeholders’ benefit should be followed. We have established
practices that allow for sufficient and visible flow of information, with adequate
safeguards in place.
7. Ethics Violation: Members of the executive board have an ethical duty to make decisions
based on the best interests of the stockholders. Further, a corporation has an ethical duty
to protect the social welfare of others, including the greater community in which they
operate. Minimizing pollution and eschewing manufacturing in countries that don’t
adhere to similar labor standards as the U.S. are both examples of a way in which
corporate governance, ethics, and social welfare intertwine.

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 8. Conflict of Interest: Avoiding conflicts of interest is vital. A conflict of interest within the
framework of corporate governance occurs when an officer or other controlling member
of a corporation has other financial interests that directly conflict with the objectives of
the corporation. For example, a board member of a solar company who owns a significant
amount of stock in an oil company has a conflict of interest because, while the board he
or she serves on represents the development of clean energy, they have a personal
financial stake in the success of the oil industry. When conflicts of interest are present,
they deteriorate the trust of shareholders and the public while making the corporation
vulnerable to litigation.

Q2. Why is post-merger integration critical for success of M&A transactions? What can be the
conditions under which they become indispensable? Explain.

The success and failure of any merger depends almost entirely on an effective post integration
process. Post integration is an ongoing process that starts right at the beginning of merger
planning, infact this is a critical aspect while deciding a potential target. Designing a long term
integration plan in one of the most challenging parts of overall M&A process. It is a meticulous
process of cointegrating and rearranging businesses with the ultimate aim of maximizing
potential efficiencies and synergies. A successful integration allows an acquirer to capture the
long-term value sought from an M&A, whereas failed integration leads to missed opportunities
and under-performance.

1. Human resource integration

2. Operations management integration
3. Pension plan integration
4. Information technology integration
5. Sales force integration

IMPORTANCE

PMI is essential for all the areas of a business including Data and Knowledge, Technology and
Systems, Internal Policies, Business Procedures, Company Culture and Organizational Structure.

1. Capture synergies: The main motive of M&A is to attain revenue, cost, operational
synergies. The proper integration ensures extracting true value from deals through adding

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 on to company’s growth, skillset or technology portfolio. a well-considered integration
can be critical to the success of a transaction.
2.  Align culture: All companies have their unique corporate cultures and their own way of
operating. A major cultural mismatch between the two entities can substantially impact the
long-term success of the deal. Differences in management approaches, working styles and
work-life balance expectations can make it difficult to create a cohesive combined
company which maximizes human capital synergies. the considerable problems of
consolidating two diverse corporate cultures are often overlooked in acquisition planning.
3. Implement effective project governance: When two entities are combined, there must be a
realistic integration timeline and careful consideration how the business will combine
different project management processes, accountability frameworks and decision protocols.
Without effective alignment of governance frameworks and clearly defining new roles and
responsibilities, an organization can ultimately suffer from allocative inefficiencies, lack of
reporting clarity, and inconsistent execution of projects.
4. Overcoming Communication Issue: or M&A Integration and Other Post Merger
Activities all the level of a company should be involved from Top Executives &
Stakeholders, Diligence Team Members, Human Resources. post-merger integration
issues should be addressed early during merger negotiations. Specifics should be
communicated to the greatest extent possible to both organizations. Open, secure
channels of communication across deal teams.
5. Linkage of strategy and structure: A basic tenet of corporate strategy is that an
organization structure must properly reflect the underlying strategy of the organization in
order to be successful.’ This simple concept is too often overlooked in merger planning.
The merger of two firms creates the need to re-think the organization structure.

Certain conditions under which post-merger integration becomes indispensable are:

1. Cross border deal: With the two countries involved, with different legal procedure, law
codes, financial policies, work culture, organizational structure, it becomes imperative to
plan for post-merger integration at the early stages.

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2. Inexperienced Management: When the companies are novice with regard to mergers, it is
even more important to form an integration team well in advance to avoid post-merger
problems.
3. Cross cultural M&As: Culture has emerged as one of the dominant barriers to effective
integrations. An organization’s culture defines its management style, structure, and
organizational practices. Each company has its own set of values which may conflict with
those of the acquired company. At the time of short listing of a target, it is very necessary
to understand the culture and HR structure of the acquiree company. For example, before
ICICI bank, HDFC Bank had considered a merger with Bank of Rajasthan. However
before it could assess the commercial and financial viability, HDFC bank management
could not see a successful integration of people and culture of the traditionally run Bank
of Rajasthan. Moreover even now after ICICI has decided to merge BOR with it there
still seems to be a lot of friction from BOR employees who fear they would not be able to
adapt themselves to the professional ICICI bank culture
4. Workload friction: by having honest conversations and setting a detailed budget
5. Different objectives: Every M&A deal presents unique business, operational and cultural
benefits, as well as challenges. To handle all the differences, companies need to first
establish a consistent set of success factors that guide post-merger integration efforts.
Such points during the process can define deal success. Common success factors that
mark M&A deals include: ensuring stability, maintaining customer focus, securing and
increasing value, integrating cultures, emphasizing employee communication, well-being,
and retention, and aligning strategy, processes and mission-critical systems.
6. Unclear Expectation: Lack of clear expectations can bring chaos and negative emotions
to mergers and acquisitions. expectations can be set by prioritizing tasks for the business
integration plan, that lead back to the key objective
7. Excessive hidden cost: the realization of such efficiencies may require the relocation of
employees due to the duplication of plants or offices within the newly merged
organization. However, the relocation of employees may also carry hidden costs. The
physical integration of facilities, the transfer of management systems, and other aspects
of combining the two firms can add significantly to this initial expense. Underestimating
hidden costs can lead to disappointment in ultimate acquisition performance.

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 8. Different organizational structure: Another problem is the difference between the
organizational structures of the companies. Since the organizational structures are
different, differences in compensation packages and designations can take place. The
company has to maintain employees at equal levels. Unable to do so, employees can feel
dissatisfied.

Q3. Protecting the company from hostile takeover attempts is the duty of the Board whereas
maximizing wealth through decisions made by the Board is the right of the shareholders.
Discuss.

When a company faces a hostile takeover attempt, they try to take defensive measure to protect
their independence and current management initiatives, or to help ensure that hostile bidders are
pressured to present their best offers. The critical challenge for executives is to determine which
defense strategies will best strengthen stockholder investments. Preventive defenses against
hostile takeovers are constructed when the company sense that it is vulnerable to attack because
of its depressed stock price, competitive weakness, market conditions, or financial pressures.

Hostile bids are unsolicited offers that challenge the strategic direction and leadership of the
company. Facilitating the takeover may result in short-term share appreciation, but the associated
loss of the company’s strategic agenda or governance team may result in longer-term stock price
declines. Alternatively, by strategizing to defeat the takeover, the firm’s executives may produce
modest stock value increases and such actions may deprive stockholders of a rare opportunity to
boost their returns as a result of a raider’s special interest in the target.

However issue becomes more complicated when defenses in the face of hostile bids appears as
an action of the board’s self-interest. Investors and shareholders are always suspicious of their
motives when they oppose a hostile bid. The question that certainly rises is, “Are the executives
trying to save their jobs at the expense of wealth gains for their shareholders?”

The BOD have a fiduciary responsibility (in good faith and trust) to shareholders and therefore,
they should be open to any bid - hostile or not, if it is in the best interest of shareholders.

Several forms of preventive defenses are discussed below:

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1. Poison Pill: A poison pill scheme can be triggered by a target company when a hostile
suitor acquires a predetermined percentage of company stock. To execute its defense, the
target company grants all shareholders (except the acquiring company) options to buy
additional stock at a huge discount. This diluted the acquiring company’s share and
intercepts its control of the company.
2. Supermajority: Supermajority amendments require approval of at least two-thirds of the
shareholders (or in some cases 90%) for a merger, tender offer, or other business
combination or for a change in the composition of the board of directors. This makes it
much more difficult for someone to conduct a takeover by buying enough stock for a
controlling interest.
3. Staggered board of directors drags out the takeover process by preventing the entire
board from being replaced at the same time. The terms are staggered, so that some
members are elected every two years, while others are elected every four. Many
companies that are interested in making an acquisition don't want to wait four years for
the board to turn over.
4. Crown Jewels defense: the target company sells its highly profitable or attractive
business/ division (called Crown Jewels) to make the takeover bid less attractive to the
raider. For example, an automobile company selling its R&D division to make the hostile
takeover less attractive.
5. White Knight: The target’s management may seek out a friendlier potential acquiring
company which is called as White Knight that will offer an equal or higher price for the
shares than the hostile bidder.
6. Pacman defense: The target company or its promoters start acquiring sizeable holding in
the acquirer/ raider company, threatening to acquire the raider itself.
7. Standstill agreement: The target acquires a promise from an unfriendly bidder to limit the
amount of stock the bidder buys and thus gains more time to build up other takeover
defenses.
8. Golden parachute: It involves contractual guarantee of a fairly large sum of compensation
is issued to the top/ senior executives of the target company whose services are likely to
be terminated in case the takeover succeeds.

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 9. Golden handshakes: It is clause in an executive employment contract with the significant
separation package.
10. Greenmail: A company may pursue the greenmail option of buying back recently
acquired stock from the putative raider at a higher price in order to avoid takeover.
Because the shares must be purchased at a premium over the takeover price, this
“payout” strategy is a prime example of how shareholders can lose out even while
avoiding a hostile takeover.

The above defenses does not necessarily will be in the best interest of the shareholders, like
Golden parachute, golden handshakes, greenmail, etc. which are merely an attractive
compensation packages designed for the top management. While strategies like poison pill,
litigation, crown jewel, supermajority might result in increase in shareholder’s wealth.

There are two contrasting hypotheses that explain why target firm's management engage in
antitakeover activity. First is the managerial- entrenchment hypothesis, the fear that the takeover
might lead to their displacement, they have an incentive to use corporate resources to defend
against an acquisition threat. However such action potentially conflict with the best interests of
the firm's security holders, who want management to maximize firm value.

In contrast, the stockholder-interests hypothesis contends that defensive strategies enable target
firms to extract higher premiums, thereby benefitting their shareholders. . In some cases
resistance may help to defeat bids considered inadequate. In other cases, playing "hard to get"
may generate more interest in a target, spark competitive bidding and ultimately result in a
higher acquisition price for target equity owners.

The company should show a clear commitment to share value enhancement to win stockholder
support and decrease the likelihood of ending up as raider targets. Managing for value may yet
be the solution to the problem of conflicting interests of management and its stockholders.

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