Merger, Acquisition & Restructuring

BASIC CONCEPTS AND FORMULAE

1. Introduction

The terms 'mergers', 'acquisitions' and 'takeovers' are often used interchangeably in common
parlance. However, there are differences. While merger means unification of two entities into one,
acquisition involves one entity buying out another and absorbing the same. In India, in legal sense
merger is known as 'Amalgamation'.

2. Reconstruction

Reconstruction involves the winding-up of an existing company and transfer of its asset and liabilities
to a new company formed to take the place of the existing company. In the result, the same
shareholders who agree to take equivalent shares in the new company carry on the same enterprise
through the medium of a new company.

3. Amalgamation or Merger

"Generally, where only one company is involved in a scheme and the rights of the shareholders and
creditors are varied, it amounts to reconstruction or reorganisation or scheme of arrangement. In an
amalgamation, two or more companies are fused into one by merger or by one taking over the
other. Amalgamation is a blending of two or more existing undertakings into one undertaking, the
shareholders of each blending company become substantially the shareholder of the company which
is to carry on the blended undertaking.

4. Types of Mergers

Horizontal Merger: The two companies which have merged are in the same industry, normally the
market share of the new consolidated company would be larger and it is possible that it may move
closer to being a monopoly or a near monopoly to avoid competition.

Vertical Merger: This merger happens when two companies that have 'buyer seller' relationship (or
potential buyer-seller relationship) come together. Example: Ebay and Paypal

Conglomerate Mergers: Such mergers involve firms engaged in unrelated type of business
operations. Such mergers are in fact, unification of different kinds of businesses under one flagship
company.

Congeneric Merger: In these mergers, the acquirer and the target companies are related through
basic technologies, production processes or markets. The acquired company represents an extension
of product-line, market participants or technologies of the acquirer. These mergers represent an
outward movement by the acquirer from its current business scenario to other related business
activities within the overarching industry structure

Reverse Merger: This type of merger is also known as 'back door listing'. This kind of merger has
been started as an alternative to go for public issue without incurring huge expenses and passing
through cumbersome process. Thus, it can be said that reverse merger leads to the following
benefits for acquiring company:

• Easy access to capital market.

• Increase in visibility of the company in corporate world.

• Tax benefits on carry forward losses acquired (public) company.

• Cheaper and easier route to become a public company.

5. Reasons and Rationale for Mergers and Acquisitions

The most common reasons for Mergers and Acquisition (M&A) are:

• Synergistic operating economies;

• Diversification;

• Taxation;

• Growth; and

• Consolidation of production capacities and increasing market power.

6. Gains from Mergers or Synergy

The first step in merger analysis is to identify the economic gains from the merger. There are gains, if
the combined entity is more than the sum of its parts. That is, Combined value > (Value of acquirer +
Standalone value of target).

The difference between the combined value and the sum of the values of individual companies is
usually attributed to synergy.

Value of acquirer + Standalone value of target + Value of synergy = Combined value

7. Principal Steps in a Successful M & A Program

• Manage the pre-acquisition phase;

• Screen candidates;

• Eliminate those who do not meet the criteria and value the rest;

• Negotiate; and

• Post-merger integration.
8. Problems for M & A in India

 Indian corporates are largely promoter-controlled and managed.

• In some cases, the need for prior negotiations and concurrence of financial institutions and
banks is an added rider, besides SEBl's rules and regulations.

• The reluctance of financial institutions and banks to fund acquisitions directly.

• The BIFR route, although tedious, is preferred for obtaining financial concessions.

• Lack of exit policy for restructuring/downsizing.

• Absence of efficient capital market system makes the market capitalisation not fair in some
cases.

• Valuation is still evolving in India.

9. Mergers in Specific Sectors

The Companies Act, 1956 and the SEBl's Takeover Code are the general source of guidelines
governing mergers. There are sector specific legislative provisions, which to a limited extent
empower the regulator to promote competition. Mergers in the banking sector require approval
from the RBI.

10. Acquisitions and Takeover

Acquisition: This refers to the purchase of controlling interest by one company in the share
capital of an existing company. This may be by:

(i) an agreement with majority holder of Interest.

(ii) Purchase of new shares by private agreement.

(iii) Purchase of shares in open market (open offer)

(iv) Acquisition of share capital of a company by means of cash, issuance of shares.

(v) Making a buyout offer to general body of shareholders.

Takeover: Normally acquisitions are made friendly, however when the process of acquisition is
unfriendly (i.e., hostile) such acquisition is referred to as 'takeover'). Hostile takeover arises
when the Board of Directors of the acquiring company decide to approach the shareholders of
the target company directly through a Public Announcement (Tender Offer) to buy their shares
consequent to the rejection of the offer made to the Board of Directors of the target company.
 Take Over Strategies: Other than Tender Offer the acquiring company can also use the following
techniques:

• Street Sweep

• Bear Hug

• Strategic Alliance

• Brand Power

11. Takeover by Reverse Bid

This is not the usual case of amalgamation of a sick unit which is non-viable with a healthy or
prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous
company is to be merged and vested in the sick company which is nonviable. A company becomes a
sick industrial company when there is erosion in its net worth. This alternative is also known as
taking over by reverse bid.

12. The Acquisition Process

The acquisition process involves the following essential stages:

(i) Defining the Acquisition Criteria

(ii) Competitive analysis
(iii) Search and screen.
(iv) Strategy development.
(v) Financial evaluation.
(vi) Target contact and negotiation.
(vii) Due Diligence (in the case of a friendly acquisition
(viii) Arranging for finance for acquisition
(ix) Putting through the acquisition and Post merger integration.

13. Takeover by Reverse Bid

In a 'reverse takeover', a smaller company gains control of a larger one. The concept of takeover by
reverse bid, or of reverse merger, is thus not the usual case of amalgamation of a sick unit which is
non-viable with a healthy or prosperous unit but is a case whereby the entire undertaking of the
healthy and prosperous company is to be merged and vested in the sick company which is non-
viable.

14. The Acquisition Process

The acquisition process involves the following five essential stages:

(i)Competitive analysis;

(ii) Search and screen;

(iii) Strategy development;

(iv) Financial evaluation; and

(v) Negotiation.

15. Defending a Company in a Takeover Bid

Due to the prevailing guidelines, the target company without the approval of the shareholder cannot
resort to an issuance of fresh capital or sale of assets etc., and also due to the necessity of getting
approvals from various authorities. Thus, the target company cannot refuse transfer of shares
without the consent of shareholders in a general meeting.

A target company can adopt a number of tactics to defend itself from hostile takeover through a
tender offer.

• Divestiture;

• Crown jewels;

• Poison pill;

• Poison Put;

• Greenmail;

• White knight;

• White squire;

• Golden parachutes; and

• Pac-man defence.

16. Legal Aspects of M & As

Merger control requirements in India are currently governed by the provisions of the Companies Act,
1956 and the Securities and Exchange Board of India (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997. ("the takeover code"). Other statutes which govern merger proposals
are the Industries (Development and Regulation) Act, 1951; the Foreign Exchange Management Act,
2000, the Income Tax Act, 1961 and the SEBI Act, 1992.

17. Due Diligence

Due diligence means research. Its purpose in M&A is to support the valuation process, arm
negotiators, test the accuracy of representations and warranties contained in the merger
agreement, fulfil disclosure requirements to investors, and inform the planners of post-merger
integration.

A due diligence process should focus at least on the following issues:

• Legal issues;

• Financial and tax issues;

• Marketing issues;

• Cross-border issues; and

• Cultural and ethical issues.

18. Target Valuation for M & A

The value of a business is a function of the business logic driving the M&A and is based on bargaining
powers of buyers and sellers. Thorough due diligence has to be exercised in deciding the valuation
parameters since these parameters would differ from sector to sector and company to company.
Some methods of valuation are:

(a) Earnings based valuation

(i) Discounted Cash Flow/Free Cash Flow: Being the most common technique takes into
consideration the future earnings of the business and hence the appropriate value
depends on projected revenues and costs in future, expected capital outflows,
number of years of projection, discounting rate and terminal value of business.

(ii) Cost to Create Approach: In this approach the cost for building up the business from
scratch is taken into consideration and the purchase price is typically the cost plus a
margin.

(iii) Capitalised Earning Method: The value of a business is estimated in the capitalized
earnings method by capitalizing the net profits of the business of the current year or
average of three years or a projected year at required rate of return.
 (iv) Chop-Shop Method: This approach attempts to identify multi-industry companies
that are undervalued and would have more value if separated from each other. In
other words, as per this approach an attempt is made to buy assets below their
replacement value.

(b) Market based valuation

(i) For Listed Companies: It is same as Capitalized Earning Method except that here the
basis is taken earning of similar type of companies.

(ii) For Unlisted Companies: The basics of valuation for listed and unlisted company stay
the same. Only thing that is limited with an unlisted company is the ready-made price
market perceives for its equity etc. In such cases we need to carry out an exhaustive/
disciplined "Benchmarking Analysis" and identify the most applicable "normalised" median
multiples for company under consideration.

(c) Asset based valuation

(i) Net Adjusted Asset Value or Economic Book Value: Valuation of a 'going concern'
business by computed by adjusting the value of its all assets and liabilities to the fair
market value. This method allows for valuation of goodwill, inventories, real estate,
and other assets at their current market value. In other words, this method includes
valuation of intangible assets and also allows assets to be adjusted to their current
market value.

(ii) Intangible Asset Valuation: Acceptable methods for the valuation of identifiable
intangible assets and intellectual property fall into three broad categories. They are
market based, cost based, or based on estimates of past and future economic
benefits.

(iii) Liquidation Value: This approach is similar to the book valuation method, except
that the value of assets at liquidation are used instead of the book or market value
of the assets. Using this approach, the liabilities of the business are deducted from
the liquidation value of the assets to determine the liquidation value of the business.
The overall value of a business using this method should be lower than a valuation
reached using the standard book or adjusted book methods.

19. Corporate Restructuring

Restructuring of business is an integral part of modern business enterprises. Restructuring usually

involves major organizational changes such as shift in corporate strategies. Restructuring can be
internally in the form of new investments in plant and machinery, Research and Development of
products and processes, hiving off of non-core businesses, divestment, sell-offs, de-merger etc.
Restructuring can also take place externally through mergers and acquisitions (M&A) and by forming
joint-ventures and having strategic alliances with other firms. The aspects relating to expansion or
contraction of a firm's operations or changes in its assets or financial or ownership structure are
known as corporate re-structuring.

20. Financial Restructuring

Financial restructuring (also known as internal re-construction) is aimed at reducing the

debt/payment burden of the corporate firm. This results into:

(i) Reduction/Waiver in the claims from various stakeholders;

(ii) Real worth of various properties/assets by revaluing them timely;

(iii) utilizing profit accruing on account of appreciation of assets to write off accumulated
losses and fictitious assets (such as preliminary expenses and cost of issue of shares
and debentures) and creating provision for bad and doubtful debts.

21. Merger Failures or Potential Adverse Competitive Effects

The reasons for merger failures can be numerous. Some of the key reasons are:

Acquirers generally overpay;

• The value of synergy is over-estimated;

• Poor post-merger integration; and

• Psychological barriers.

Most companies merge with the hope that the benefits of synergy will be realised. Synergy will be
there only if the merged entity is managed better after the acquisition than it was managed before.
Therefore, to make a merger successful, companies may follow the steps listed as under:

• Decide what tasks need to be accomplished in the post-merger period;

• Choose managers from both the companies (and from outside);

• Establish performance yardstick and evaluate the managers on that yardstick; and

• Motivate them.

22. Acquiring for Shares

The acquirer can pay the target company in cash or exchange shares in consideration. The analysis of
acquisition for shares is slightly different. The steps involved in the analysis are:

• Estimate the value of acquirer's (self) equity;

 • Estimate the value of target company's equity;

• Calculate the maximum number of shares that can be exchanged with the target company's
shares; and
• Conduct the analysis for pessimistic and optimistic scenarios.

Question 1

Explain the term "Demerger".

Answer

Demerger: The word 'demerger' is defined under the Income-tax Act, 1961. It refers to a situation
where pursuant to a scheme for reconstruction/restructuring, an 'undertaking' is transferred or sold
to another purchasing company or entity. The important point is that even after demerger; the
transferring company would continue to exist and may do business.

Demerger is used as a suitable scheme in the following cases:

• Restructuring of an existing business

• Division of family-managed business

• Management 'buy-out'.

While under the Income tax Act there is recognition of demerger only for restructuring as provided
for under sections 391 - 394 of the Companies Act, in a larger context, demerger can happen in other
situations also.

Question 2

Explain synergy in the context of Mergers and Acquisitions.

Answer

Synergy May be defined as follows:

In other words, the combined value of two firms or companies shall be more than their individual
value. This may be result of complimentary services economies of scale or both A good example of
complimentary activities can a company may have a good networking of branches and other
company may have efficient production system. Thus, the merged companies will be more efficient
than individual companies.

On Similar lines, economics of large scale is also one of the reasons for synergy benefits. The main
reason is that, the large-scale production results in lower average cost of production e.g. reduction
in overhead costs on account of sharing of central services such as accounting and finances, Office
executives, top level management, legal, sales promotion and advertisement
These economics can be "real" arising out of reduction in factor input per unit of output, whereas
pecuniary economics are realized from paying lower prices for factor inputs to bulk transactions.

Question 3

Explain the term Buy-Outs'.

Answer

A very important phenomenon witnessed in the Mergers and Acquisitions scene, in recent times is
one of buy - outs. A buy-out happens when a person or group of persons gain control of a company
by buying all or a majority of its shares. A buyout involves two entities, the acquirer and the target
company. The acquirer seeks to gain controlling interest in the company being acquired normally
through purchase of shares. There are two common types of buy-outs: Leveraged Buyouts (LBO) and
Management Buy-outs (MBO). LBO is the purchase of assets or the equity of a company where the
buyer uses a significant amount of debt and very little equity capital of his own for payment of the
consideration for acquisition. MBO is the purchase of a business by its management, who when
threatened with the sale of its business to third parties or frustrated by the slow growth of the
company, step-in and acquire the business from the owners, and run the business for themselves.
The majority of buy-outs is management buy-outs and involves the acquisition by incumbent
management of the business where they are employed. Typically, the purchase price is met by a
small amount of their own funds and the rest from a mix of venture capital and bank debt.

Internationally, the two most common sources of buy-out operations are divestment of parts of
larger groups and family companies facing succession problems. Corporate groups may seek to sell
subsidiaries as part of a planned strategic disposal programme or more forced reorganisation in the
face of parental financing problems. Public companies have, however, increasingly sought to dispose
of subsidiaries through an auction process partly to satisfy shareholder pressure for value
maximisation.

In recessionary periods, buy-outs play a big part in the restructuring of a failed or failing businesses
and in an environment of generally weakened corporate performance often represent the only
viable purchasers when parents wish to dispose of subsidiaries.

Buy-outs are one of the most common forms of privatisation, offering opportunities for enhancing
the performances of parts of the public sector, widening employee ownership and giving managers
and employees incentives to make best use of their expertise in particular sectors.

Question 4

What is take over by reverse bid?

Answer
Generally, a big company takes over a small company. When the smaller company gains control of a
larger one then it is called "Take-over by reverse bid". In case of reverse takeover, a small company
takes over a big company. This concept has been successfully followed for revival of sick industries.

The acquired company is said to be big if any one of the following conditions is satisfied:

(i) The assets of the transferor company are greater than the transferee company;

(ii) Equity capital to be issued by the transferee company pursuant to the acquisition exceeds its
original issued capital, and

(iii) The change of control in the transferee company will be through the introduction of
minority holder or group of holders.

Reverse takeover takes place in the following cases:

(1) When the acquired company (big company) is a financially weak company

(2) When the acquirer (the small company) already holds a significant proportion of shares of
the acquired company (small company)

(3) When the people holding top management positions in the acquirer company want to be
relived off of their responsibilities.

The concept of take-over by reverse bid, or of reverse merger, is thus not the usual case of
amalgamation of a sick unit which is non-viable with a healthy or prosperous unit but is a case
whereby the entire undertaking of the healthy and prosperous company is to be merged and vested
in the sick company which is non-viable.

Question 5

Write a short note on Financial restructuring

Answer

Financial restructuring, is carried out internally in the firm with the consent of its various
stakeholders. Financial restructuring is a suitable mode of restructuring of corporate firms that have
incurred accumulated sizable losses for I over a number of years. As a sequel, the share capital of
such firms, in many cases, gets substantially eroded I lost; in fact, in some cases, accumulated losses
over the years may be more than share capital, causing negative net worth. Given such a dismal
state of financial affairs, a vast majority of such firms are likely to have a dubious potential for
liquidation. Can some of these Firms be revived? Financial restructuring is one such a measure for
the revival of only those firms that hold promise/prospects for better financial performance in the
years to come. To achieve the desired objective, 'such firms warrant / merit a restart with a fresh
balance sheet, which does not contain past accumulated losses and fictitious assets and shows share
capital at its real/true worth.

CVMA 17-11-2020

Poison Pill
Green Mill - It is a practice of purchasing enough shares in firm to threaten a takeover thereby
forcing target firm to buy those shares at premium. It is also known as "bon voyage bonus" or
"goodbye kiss". This is a tactic adopted by unfriendly shareholders to avoid hostile takeovers

Poison Pill: It is a type of defensive tactic used by board of directors against a takeover. The common
types of poison pills are

i) Preferred Stock Plan

ii) Flip Over rights plan

iii) Ownership creep in plan

iv) Back end rights plan

v) Voting plan

All these tactics are achieved through shareholders right plan which involves rights to shareholders
(existing) to buy more shares at discount if that shareholders buys a 20% or more shares in the
company. These rights are provided in the memorandum and articles of the company. This particular
poison pill acts as a barrier when a bidder tries to take over the control of the company making it
costlier. However, though in many EU countries including Canada allows such kind of right plans,
however Indian law do not permit the same.

Blackmail: In blackmail engagement the bank of the target firm refuses financing options to the firm
with takeover bids. The blackmail provides

i)thwarting M&A through financial restrictions.

ii) Increasing transaction cost in competitors’ firm

iii) forcing more time for the target firm to develop other strategies and resources for M&A.

Crown Jewel Defence: When a company is threatened with takeover, the target company sells of an
important asset to a friendly third party or spin off valuable asset in separate entity thereby making
takeover uneconomical or unattractive.

Pension Parachute: It is a form of Poison Pill that prevents the raiding firm of hostile takeover from
utilising pensions assets for takeover.

People Pay: This is an anti takeover defence where the current management of the company
threatens to quit enmass in the event of successfull hostile takeover.
Golden Parachute: This is an agreement between company and employee (usually upper executive)
specifying that employee will receive significant benefits if employment is terminated (Charge in
control benefits). This is also known as golden handshake which may include cash bonus, stock
options or other benefits thereby making the overall valuation of company lower. Thus making it
unattractive.

Grey Knight: These are friendly investors which enters the bid for a hostile takeover and competing
with Black Knight (unfriendly bidder). The intention by Grey Knight is to circumbend the takeover by
unfriendly entity by offering a more higher and attractive enticing bid in consultaton with
management company.

White Squire: These are the friendly investors having minority stake. Normally whie squire doesnt
have the intention but acts as defence.

White Knights are friendly bidders who may opt for majority stakes.

Examples:

2009 FIAT takes over Crisler

2006 SEBERTAL acted as white Knight to Arseler between merger of Arseler and Mittal.

Jones Town Defence: Extreme tactic against hostile takeover also known as Suicide pill where firm
engages in tactics that might threaten the firms existence that might thwart in imposing takeover
bid. This is based on 1978 Jones Town mass suicide in Guyana.

Killer Bees: Here the target company employees firms or individuals fend off take over bids. These
include investent bankers, accountants, attorneys, tax specialist etc. These individuals or firms
utilises various anti take over strategies to make the bid economically unattractive and costly.

Lobster Trap: In this target Company includes the provision in its charter (Memo and articles)
preventing individuals with 10% or more ownership of convertible securities from transferring it to
(converting) voting stock.

Nancy Reagan Defence: Used by BOD of target company wherein they choose to say no. This
defence is also called "Just Say No". This is based on an advertising campaign headed by then first
lady Nancy Reagan as a part of US war on drugs aiming to discourage children from engaging in
illegal use of drugs. This tactic was discusse during takeover of Walt Disney by ComCast. During the
same discussion the second strategy or defence was PacMan Defence wherein company that is
threatened with Hostile takeover (turns the tables) by attempting to acquire the acquiree or would-
be-buyer.