Session 1.

Introduction to Mergers and

Acquisitions
PGP, IIM INDORE
 Evaluation Criteria
•Mid-term Exam – 30%
•End-term Exam – 30%
•Class Participation – 10%
•Group Assignment – 30%*
• *Groups of 6 members
• Assume the role of an investment banker – representing buy side
I. Select an M&A deal from the list (to be shared, i.e., deals announced in the past three years)
II. Domestic or an International deal. The acquirer and the target firm have to be publicly listed.
III. No two groups can consider the same deal across the two sections (CR to float a spreadsheet for the EOIs)
IV. Other alternate target(s): Based on the understanding of competitive landscape, growth, market share, and industry
analysis
V. Valuation, other analysis, deal structure (payment), deal financing.
VI. Prepare a pitch book
VII. Pitch book presentation & Submission (deadline to be announced)
Mergers and Acquisitions
•Acquisition / Takeover: Purchase of controlling
stake/ assets/ segment
•Merger: When two or more companies
combine to form one company (one of the
existing companies survives or a new co. is
formed)
Mergers and Acquisitions
•‘Dell Closes $60 Billion Merger with EMC’, Sep
2016
• With EMC’s enterprise storage business
• The largest technology merger in the history
•‘Dell completed its acquisition of EMC
Technologies on Wednesday.’
•‘The merger between Dell and EMC is a response
to overall declining markets in both Dell’s and
EMC’s core businesses as technology shifts to
mobile devices and toward lower-margin
hardware such as servers and storage used in
cloud computing.’

•https://www.wsj.com/articles/dell-closes-60-
billion-merger-with-emc-1473252540
Mergers and Acquisitions
•‘Gruh Finance merger with Bandhan
Bank completes’
•‘….Shareholders of the Kolkata-headquartered
bank had approved its proposed acquisition of
Gruh Finance’
•Deal was announced in Jan 2019
•Deal value USD 3.165 bn
•Shareholders of Gruh Finance to receive three
shares of Bandhan Bank for every five shares
held by them in the former
•https://www.financialexpress.com/industry/bank
ing-finance/gruh-finance-merger-with-bandhan-
bank-completes/1738877/
Relevance of M&A Deals
Build or Buy: Enter new market, acquire new
customers, build new technology, etc. through internal
investments or through purchase
◦ Apple vs. Microsoft
◦ Trendsetting product innovation led to growth at Apple. Apple usually
makes small acquisitions
◦ Microsoft: More than 200 acquisitions since 1986: Skype -8.5 bn
(2011), Nokia -$7.2 bn (2013), LinkedIn -$26 bn (2016), Nuance - $
19.7 bn (2021), Activision Blizzard - $ 68.7 bn (2022)

Why are M&As needed?

Growth, synergies, strategic realignment, scope &
scale economies, access to resources and capabilities,
market entry, resilience, etc.
Synergies
◦ Operating Synergies: Reduction of costs, economies of
scale and scope – cost & revenue synergies (efficiency
improvements)
◦ Financial synergies
What causes M&A?
•Tata Digital Ltd. acquired majority stake in Bigbasket (March 2021)
• Acquired 64.3% stake in supermarket Grocery Supplies Pvt. Ltd. (Bigbasket)
• Deal valued at US$ 1.2 billion
• Part of Tata Group’s strategy to build a digital consumer ecosystem
• July 2021: Acquired majority stake in e-pharma player 1Mg

•Microsoft announced the acquisition of Activision Blizzard (Jan 2022)

• The largest acquisition ever by Microsoft: US$ 68.7 billion
• The all-cash $68.7 billion deal will make Microsoft the third largest video game co. by global revenue
• Help compete with tech rivals like Meta
What causes M&A?
•Adani Green Energy Ltd acquired SB Energy Holdings (May 2021)
• Indian’s largest renewables M&A deal
• Deal value: US$ 3.5 billion
• A portfolio of renewable energy projects
• The Adani group has committed to invest over USD 20 billion in alternative energy in the next ten years
• Supports the acquirer’s goal of becoming one of the significant players in renewable power space

•Wipro Ltd. undertook its biggest inorganic investment by acquiring The Capital Markets Co NV
(April 2021)
• Capco - An IT consulting firm based in the UK and servicing the financial services industry across the
American sub-continent, Europe and Asia-Pacific regions
• Deal value: US$ 1.45
What causes M&A? M&A Deals India
•Arcellor Mittal with Nippon Steel Corp. acquired Essar Steel India
• USD 6 bn, insolvency resolution process.
• Announced in March 2018, final approval in Nov 2019
•IndusInd Bank acquired the country's leading micro-finance player Bharat Financial Inclusion
Limited (erstwhile SKS Microfinance, the country first for-profit micro lender).
• Closed in July 2019, announced in Oct 2017, INR 15000 crores
• Bharat Financial shareholders will get 639 shares of the bank for every 1,000 held
• Access to scale & scope: access to 2 crore customers in micro finance segment, complimentary network,
double the branch count, lower costs of funds, etc.
•Walmart Acquired Flipkart in 2018
• US retail giant Walmart acquired 77% stake in Flipkart (USD 16 bn). Objective was to take on rival
Amazon’s global expansion. One of the big ticket deals in India, and one of the largest private equity
exits in India.
What causes M&A? M&A Deals India
•Dewan Housing Finance Corporation Ltd (DHFL) was acquired by Piramal Group company (Jan
2021)
• Deal value: US$ 4.71 billion
• There was a multi-stage bidding process that involved bidders like Oaktree Capital Management and
Adani Group.

•Think and Learn Pvt. Ltd - Byju’s acquisitions in edtech space

• WhiteHat Jr. for US$ 300 mn (2020), Aakash Educational Services for US$ 1 billion (2021), Great Learning
for US$ 600 mn (2021), including others – Gradeup, Tynker, GeoGebra, etc.
What causes M&A? M&A Deals India
Bandhan Bank and Gruh Finance Merger (July 2019)
◦ Deal value USD 3.165 bn
◦ Enable Bandhan Bank to reduce risk arising out of geographical concentration
Idea Vodafone Merger (2018): The combined is named Vodafone Idea Ltd
◦ Deal Value USD 11.62 bn
Kotak Mahindra-ING Vysya Bank merger in 2015
◦ ING Vysya merged with Kotak (surviving entity), creating the fourth largest private sector bank in India
◦ Shareholders of ING Vysya receive shares of Kotak in exchange of shares in ING Vysya at the approved share exchange (“swap”) ratio.
◦ All ING Vysya branches and employees become Kotak branches and employees.
◦ ING Vysya’s CEO designate, Mr Uday Sareen, inducted into the top management of Kotak reporting directly to Mr Uday Kotak, Executive Vice Chairman
and Managing Director of Kotak

Acquisitions: Myntra (owned by Flipkart) acquired Jabong in 2016, Tata Steel acquired Corus Steel PLC in 2007
◦ Both operated as separate entities

Acquisition of assets: Ultratech Cement acquired Jaypee Group’s Cement plants INR 16000 crore deal, Total
capacity post deal 90MT
 What causes M&A
• Entry or expansion into new markets – geographic or product markets
• Acquisition of Zain Africa by Bharti Airtel for USD 10.7 bn in 2010
• Access to 15 African countries

• ONGC acquired Imperial Energy PLC for USD 2.1bn in 2008

• Access to European energy market

• Access to technology
• Tata Steel became one of the top 5 steel producers in the world (from 56th) when it acquired Corus in 2007
• Access to Corus’s network in Europe, goodwill, technology (high margin products)

• Suzlon Energy acquired RE Power of Germany in deal valued at US 1.7 bn in 2007

• Access to European energy market and target's technological strengths

• Respond to competition
• Idea-Vodafone merger – an important motivation was to respond to competitive pressures
• Merged entity the largest Telecom company in India, with customer base of 400 mn customers, with 35% and 41% of revenue market
share.
What causes M&A (contd.)
•Need to diversify: Position the firm in higher-growth products or markets
• Mergers in 1960s

•When sum of the parts is worth more than the combined company
• Mergers and acquisitions in 1980s

•Hubris, i.e., Managerial pride

• Acquirer’s believe their valuation of the target is more accurate than the market’s, causing to overpay
by overestimating synergies

•Market power: Actions taken to boost selling price above competitive levels by affecting either
supply or demand
 What Causes M&A?
Year Acquirer Target Deal Value Industry Significance of the Deal

2006 Tata Steel Corus USD 12.2 Steel Tata Steel became one of the top 5 steel producers in the
bn world (from 56th). Leverage Corus’s network, goodwill,
technology (high margin products)
2007 Hindalco Novelis Inc USD 6.2 bn Aluminiu Hindalco became the world's largest manufacturer of
Industries (Aditya m Aluminium, and entered Fortune 500 listing of companies
Birla Group) (by Sales revenues)

2007 Suzlon Energy Ltd.RE Power USD 1.7 bn Power and Access to European energy market and target's
Energy technological strengths

2008 ONGC Imperial USD 2.1 bn Oil & Gas The deal helped ONGC in having its presence in Siberia, one
Energy PLC of the largest oil and gas producing regions
2008 Tata Motors Jaguar and USD 2.3 bn Automobil Acquisition of two iconic brands made Tata Motors a global
Land Rover e passenger car company
2010 Bharti Airtel Zain Africa BV USD 10.7 Telecom Gave Bharti Airtel access to 15 African countries
bn
 What Causes M&A?
Year Acquirer Target Deal Value Industry Significance of the Deal

2016 HDFC Standard Max Life USD 9.73 bn Financial The deal would have created the largest private section life
Life Insurance services insurance company in India, but the deal didn’t go through

2016 Rosneft, Essar Oil USD 12.9 bn Oil & Gas The deal will give Rosneft access to Essar’s fuel retailing
Trafigura and network of 2,700 fuel pumps
United Capital
2016 Ultratech Jaiprakash USD 2.45 bn Cement Asset purchase. Target could reduce their debt burden
Cement associates
Cement
Assets

2016 Makemytrip Ibibo USD 1.8 to 2 bn E- One of the biggest acquisitions in the India's online travel
commer space. In a highly unpenetrated and fragmented market the
ce merged entity can become truly a one stop shop for Indian
travellers (MMT, Go Ibibo, Redbus, etc under one umbrella)
 What Causes M&A?
Year Acquirer Target Industry Significance of the Deal

2017 Vodafone India Telecom Makes the merged entity second largest in the world and the
and Idea celluar largest in India (combined value $23 bn). It would have customer
base of 400 mn customers, with 35% and 41% of revenue market
share. The merged entity would be able to withstand the fierce
competition from Rel-Jio
2018 Walmart Flipkart E- US retail giant Walmart acquired 77% stake in Flipkart (USD 16 bn).
commerce Objective was to take on rival Amazon’s global expansion. One of
the big ticket deals in India, and one of the largest private equity
exits in India.
2018 Tata Steel Bhushan Steel Tata steel won the bid to acquire Bhushan Steel in an insolvency
(Bamnipal Steel Steel Ltd. auction
Ltd.)

2019 L&T Mindtree Information Considered as a hostile deal. L&T mounted a takeover bid on Mind
Technology tree when it acquired 20.32% stake from one of its major
shareholders.
 Merger waves in the US Wave 5
Electronics, Media,
Telecommunication,
Wave 1 Wave 2 Wave 3 High Technology, E-
Wave 4 commerce
Hydraulic Conglomerate Wave 6 –
power, Power/Utili transactions 2004 to
ites, Steam 2008
textiles,
engines,
iron &
steel,
Steel, Oil
railways

Globalisation
and presence
of Private
equity

Martynova, M. & Renneboog, L. (2008). ‘A century of corporate takeovers: What have we learned and where
do we stand?’, Journal of Banking and Finance, 32, 2148-2177.
Horizontal Consolidation (1897-1904)
•Resulted in concentration in metals, transportation, and mining
industry
•M&A boom ended by 1904 stock market crash and fraudulent
financing
Increasing Concentration (1916-1929)
Spurred by
◦ Entry of U.S. into WWI
◦ Post-war boom

Boom ended with

◦ 1929 stock market crash
◦ Passage of Clayton Act which more clearly defined monopolistic practices
The Conglomerate Era (1965-1969)
Conglomerates bought companies in unrelated industries
◦ Motivation was to pursue growth in unrelated industries

Key deals:
•Georgia Pacific acquired Hammond Lumber Company, Chrysler Corporation acquired Briggs
Automotive
•Loews Theateres acquired Lorillard P Corporation (tobacco co.), Singer Corporation (Sewing m/c
mfg.) acquired General Precision Equipment Corporation (Mfg – defense and space)

The wave came to an end with the Oil Crisis and stock market crash
The LBO Wave (1981-1988)
Strategic U.S. buyers and foreign multinationals dominated first half of
decade
Second half dominated by financial buyers
◦ Buyouts often financed by junk bonds
◦ Method of payment used was primarily Debt financed Cash

Bust-up takeovers, hostile takeovers were prominent

Key Deals: KKR – RJR Nabsico, KKR – Beatrice Co., Phillips Morris – Kraft
Foods
Era ended with bankruptcy of several large LBOs and stock market crash of
late 1980s
Age of Strategic Megamergers (1992-2001)
Dollar volume of transactions reached record in each year between 1995 and
20001
Primarily deals were undertaken in BFSI, Telecommunications, Media,
High-technology industries, E-commerce, Petrochem
The method of payment used was predominantly equity
Key deals: AOL Time Warner, HP Compaq (end of the wave) were
undertaken, Vodafone – Mannesmann, Vodafone – Airtouch, Exxon-
Mobil.
Period ended with the collapse in global stock markets and worldwide recession
1The cumulative dollar value of M&As during this period in the U.S. was $6.5 trillion, With $3.5 trillion taking place in the last
two years.
Age of Cross Border and Horizontal Megamergers (2003
– 2007)
Average merger larger than in 1980s and 1990s, mostly horizontal, and cross border
Concentrated in banking, telecommunications, utilities, healthcare, and commodities (e.g., oil,
gas, and metals)
Spurred by
◦ Continued globalization to achieve economies of scale and scope;
◦ Ongoing deregulation;
◦ Low interest rates;
◦ Increasing equity prices, and
◦ Expectations of continued high commodity prices
Deals: JP Morgan Chase – Bank One Corporation, Royal Dutch – Shell Transport and Trading,
AT&T – Bell South, Large cross border deals from India
Period ended with global credit market meltdown and 2008-2009 recession
Similarities and Differences Among Merger Waves
Similarities
◦ Occurred during periods of sustained high economic growth
◦ Ample Capital liquidity and Low cost of capital
◦ Rising stock market
◦ Ended with stock market crash
Do M&As create value?
•The sobering reality is that only about 20 per cent of all mergers really
succeed. Most mergers typically erode shareholder wealth…the cold, hard reality
that most mergers fail to achieve any real financial returns…very high rate of
merger failure…rampant merger failure…(Grubb & Lamb, 2000)
•New Evidence: M&A’s create value
• Certain conditions under which M&A deals may destroy value
Performance of Indian Companies

• Study 2013: Indian cos. that closed deals between 2005 & 2011
• Benchmark – Nifty & Sensex, > Index (by 10%) – exceed value, <Index by 10% - Destroy value
• Synergies are more tangible with asset based deals (as compared to people based deals – in case of
Services sector)

• Ref. http://blogs.ft.com/beyond-brics/2013/04/09/india-ma/
Why M&A Deals do not succeed?
•Overpayment – an overarching cause for Deal Failure
•New Evidence suggests that deals undertaken by countries other than US, UK and Canada create
value
• US, UK, Canada bidders pay an average of 45% premium
• Similar numbers are in 20s for rest of the world

• Ref.: Gains from Mergers and Acquisitions Around the World: New Evidence by G. Alexandridis, D.
Petmezas, and N.G.Travlos, Financial Management.
References
•DePamphilis, D.M. (2014). An Introduction to Mergers, Acquisitions, and Other Restructuring Activities.
Mergers, Acquisitions, and Other Restructuring Activities (pp. 3 to 35). San Diego, USA: Elsevier Inc.
•Martynova, M., & Renneboog, L. (2008). A century of corporate takeovers: What have we learned and
where do we stand?. Journal of Banking & Finance,32(10), 2148-2177.
Session 2, 3 and 4. DCF and Multiples
Approach – Part I
PGP, IIM INDORE
Recap Session 1
•Motives of M&A transactions
• Rationale for undertaking inorganic investments

•M&As have occurred in waves

• Brief History of merger waves in the US
• Common features across waves:
• Triggered by changing competitive dynamics possibly triggered by technological, economic and regulatory factors
• Accompanied with Stock market boom and ample capital market liquidity
• Often end with stock market crash
• Wave of 1980s: Bust up takeovers, hostile transactions, Leveraged Buyouts, use of Junk bonds
• Waves of 1990s and 2000s: Emergence of Significant Cross Border activity
DCF Valuation – Revision of Steps
Estimate the future earnings and cash flows of the firm being valued
◦ Cash flows to either equity investors (CF to Equity) or to all claimholders (CF to Firm)

Estimate when the firm will reach “stable growth”, and the expected growth rate thereafter
Estimate the discount rate or rates to use in the valuation
Choose the right DCF model for this asset and value it.
A refresher on FCFF Valuation
•PV of Projection period (Forecast Period) cash flows + PV of TV
!" !" !"# !" !"!
◦ ($%&! )! + ($%&" )" + ($%&# )#
+ …… + ($%&$ )$ + ($%& )!
! " $ !

•Cash flows to firm: Cash flows to all claimholders in the firm

•FCFF = EBIT(1-t) + Depreciation (& other non-cash charges) –Capital expenditure –
Change in Net working Capital
• Appropriate Discount Rate – WACC
Cost of Capital
Cost of Capital for discounting FCFF
Cash flow available for (free) for distribution to all investors (Equity + Debt)
◦ Appropriate discount rate: Weighted average cost of capital

FCF Valuation is also called the WACC approach

WACC = [(D/V) kd (1-t)] + [(E/V) ke]
◦ D = Proportion of Debt in the total Value
◦ E = Proportion of Equity in the total Value
◦ V=E+D
◦ kd = Cost of Debt
◦ t = Coporate Tax Rate
◦ Ke = Cost of Equity
Cost of Debt
•Expected return on a long-term fixed-rate obligation of a credit quality that corresponds to the
capital structure ratios built into the WACC Formula
The interest rate likely to be charged on new debt.
Find the yield on the company’s debt, if it has any.
Find the bond rating for the company and use the yield on other bonds with a similar rating.
• Default spread
• Rd = Rf + Default spread

•What if the debt is neither traded nor rated?

• Synthetic debt rating
Synthetic debt ratings
Synthetic Debt rating: Illustration
Bond rating based on Different Financial ratios
Ratios AAA AA A BBB BB B CCC
Total Debt/Total Capital 6.23% 20% 35% 40% 45% 57% 75%
EBIT Interest Coverage ratio 23 13 6 4 2 0.9 0.43
Free operating cash flow/Total Debt 104% 41% 25% 16% 7.90% 2.60% 1.40%
Default Risk Premium 1.20% 1.65% 1.80% 2.50% 2.75% 3.50% 4%

Current Capital Structure (Debt/Total Capital) 20% Book Value of Debt (USD Million) 2100
Current Beta 1.1 Book Value of Equity (USD Million) 1200
Risk free rate 6.50% Current Stock price (USD) 42

Market Risk Premium 7.50% Number of Shares Outstanding (Million) 250

Current EBIT (USD Million) 1400 Current Interest Expense (USD Million) 100

What is the Weighted average cost of capital for the firm as per its current capital structure?
Assume tax rate as 34%
Revision of Fin II concepts
Synthetic Debt rating
Cost of Debt Weighted Average Cost of Capital
◦ 𝑊𝐴𝐶𝐶 = 𝑘𝑑 ∗ 𝑊𝑑 ∗ 1 − 𝑡 + [𝑘𝑒 ∗ 𝑊𝑒]
•Synthetic rating: AA
◦ WACC = [8.15% * 20% * (1-0.34)] + [14.75% *
•DRP: 1.65% 80%] = 13.039%

•Kd = Rf + DRP = 6.5% + 1.65% = 8.15%

Cost of Equity
•ke =Rf + β*MRP= 6.5% +1.1*7.50%= 14.75%

Revision of Fin II concepts

FCFF: EBIT and NI route
Free Cash Flow Example
Porjections 2022 2023 • Capex is 150% of Depreciation
Sales 25,000.00 35,000.00
COGS (excluding depr.) 5,400.00 7,700.00
• Change in working capital is 2.5% of Sales
Gross Profit 19,600.00 27,300.00 • Estimate Free Cash Flow.

SG&A 15,000.00 20,000.00

EBITDA 4,600.00 7,300.00

Depreciation 500.00 700.00

Amortization 50.00 70.00

EBIT 4,050.00 6,530.00

Interest exps. 500.00 900.00

EBT 3,550.00 5,630.00
Taxes (35%) 1,242.50 1,970.50
Net Income 2,307.50 3,659.50
Free Cash Flows
Free Cash Flow 2022 2023
EBIT 4,050.00 6,530.00

Less. Taxes 1,417.50 2,285.50

Nopat 2,632.50 4,244.50

Add. Dep 500.00 700.00

Add. Amortization 50.00 70.00

Less. Capex 750.00 1,050.00

Less. Change in NWC 625.00 875.00

Free Cash Flow 1,807.50 3,089.50

Free Cash Flows: Net Income Route
Free Cash Flow 2022 2023

Net Income 2,307.50 3,659.50

Add. Interest 500.00 900.00

Less. Interest tax shield 175.00 315.00

Add. Dep 500.00 700.00

Add. Amortization 50.00 70.00

Less. Capex 750.00 1,050.00

Less. Change in NWC 625.00 875.00

Free Cash Flow 1,807.50 3,089.50

An illustration on Valuation (Excel file – Exercise 1)
References
Ruback, R.S. (1995). An Introduction to Cash Flow Valuation Methods. HBS No. 9-295-155. Boston, MA:
Harvard Business School Publishing
Leuhrman, T.A. (2009). Corporate Valuation and Market Multiples. HBS No. 9-206-039. Boston, MA:
Harvard Business School Publishing.
Rosenbaum, J and Pearl, J. (2013). Discounted Cash Flow Analysis. Investment Banking: Valuation,
Leveraged Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Session 3. DCF and Multiples Approach: Part
II
PGP, IIM INDORE
Recap Session 2
•DCF Valuation: Free Cash Flows to the Firm or Free Cash Flow Approach
• The procedure: EBIT route, Net Income route
• The appropriate cost of capital and the components of WACC
• Synthetic debt rating
• An abridged valuation exercise

•What drives the choice of the number of years in the projection period?
• When can the projections be terminated?
An illustration on Valuation (Excel file)
•Assignment
•The rationale underlying the design of projections
• Function of Revenues and other aspects

Assignment for Discussion in the next session:

◦ Estimating Growth rates, interim and TV
Market Value Balance Sheet
Value of Assets Equity and Liabilities
Value of Operations: Assets used in Debt Borrowed money
PV of FCFs of Projection Operations
Period + PV of TV

Non-operating Assets: Assets not

Cash & Cash used in Equity Owner’s funds
Equivalents Operations

Firm Value Firm Value

Enterprise Value
Economic Value Balance Sheet
PV of future cash from business
$1500
operations

Cash $200 Debt $650

Marketable securities $150 Equity $1200

$1850 $1850
Enterprise Value or
Value of operations
Firm Value vs. Enterprise Value
Value from DCF (FCFF or CCF or APV) = Enterprise Value
Value of Non-operating assets
◦ Cash and other non-operating assets
◦ Excess cash (non-operating cash), marketable securities, Long-Term Investment (Stake held in other
companies)

Value (Firm) = Value of Operations (i.e. the Enterprise) + Value of Non-operating Assets
Value (Firm) – Value of Debt = Value of Equity
Value of Equity / No. of outstanding shares = Value per equity share

Revision of Fin II concepts

Approaches for Estimating Terminal
Value
1. Terminal Value as a Growing Perpetuity Cash Flow
◦ Implied formula: [FCF(1+g)] / (WACC – g)

2. Terminal Value as a Stable Perpetuity Cash Flow

◦ Implied formula: FCF / WACC

3. Terminal Value as a Multiple

Illustration: Estimating Terminal Value
using Multiples
•Terminal Value using Multiples Following is the data collated for a set of
comparable companies which are publicly
•You are valuing - Hyperloop Engineering, a listed.
privately held firm. Following are the relevant
forecasts for year 5 (of the projection period): Company P/E Ratio Price/Book ratio EV/Sales

WDC 14.45 1.25 1.36

TW Inc 13.52 1.18 1.29

Particulars Year = 5
TFCF FOXA 16.32 1.46 1.5
Sales ($ mn) 4250
CWX 15.63 2.14 2.43
Book value of Debt ($ mn) (net of cash) 2550
Book value of equity ($ mn) 3000 Cesla 18.54 2.2 2.52

Net Income ($ mn) 325 Average 15.692 1.646 1.82

•Estimate the TV based on the three multiples.

Illustration: Estimating Terminal Value
Particulars Year = 5 Terminal Value_P/E Ratio
Sales ($ mn) 4250 ◦ $7649.9 mn
Book value of Debt ($ mn) 2550
Terminal Value_P/B Ratio
Book value of equity ($ mn) 3000
◦ $7488 mn
Net Income ($ mn) 325

Terminal Value_EV/Sales Ratio

Company P/E Ratio Price/Book ratio EV/Sales ◦ $7735
WDC 14.45 1.25 1.36

TW Inc 13.52 1.18 1.29

TFCF FOXA 16.32 1.46 1.5

CWX 15.63 2.14 2.43

Cesla 18.54 2.2 2.52

Average 15.692 1.646 1.82

Summary of FCFF
•FCFF approach discounts FCFF at WACC
•WACC is estimated based on an important assumption
• D/E over the projection/terminal period is constant and known

•WACC, however, may not be appropriate if the leverage is expected to change

• That is, in Leveraged Buyouts
• Debt levels may be known and changing/decreasing
Capital Cash Flow (CCF) Approach
 Cash Flow Valuation Techniques
Earning Before Interest and Taxes ( EBIT)

Plus Depreciation, Less Capex, Less Change in Working Capital

Operating Cash Flow

Subtract Actual Taxes

Subtract Hypothetical Taxes
Tax Rate
Tax Rate X ( EBIT)
X (EBIT – Interest)

Capital Cash Flow Free Cash Flow

Assignment: What would be an Discount at Weighted Average Cost of

appropriate discount rate for Capital
discounting CCF?
Valuation of Corus PLC.
Case Information
•Tata Corus deal was first announced in October 2006, and finalized in early 2007.
•A large portion of the transaction was funded by raising debt from different sources.
•Tata Steel had crude steel production of 5.3 million tons across India and South-East Asia.
•Corus had a crude steel production of 18.2 million tons in 2005.
•The combined entity became the fifth largest steel company in the world.
•Acquisition Debt, and other case facts about the debt
• D/E ratio of 16:84 in normal course of business and after the projection period
• Pre-tax cost of debt of 6% when D/E is 16:84
•Beta of Corus – 1.16, and expected stable growth rate – 2%
•Assignment: To calculate CCF for Corus for at least one year (Ref. the Exhibits – Exercise 2)
References
Ruback, R.S. (1995). An Introduction to Cash Flow Valuation Methods. HBS No. 9-295-155. Boston, MA:
Harvard Business School Publishing
Leuhrman, T.A. (2009). Corporate Valuation and Market Multiples. HBS No. 9-206-039. Boston, MA:
Harvard Business School Publishing.
Rosenbaum, J and Pearl, J. (2013). Discounted Cash Flow Analysis. Investment Banking: Valuation,
Leveraged Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Session 4. DCF and Multiples Approach:
Part III
PGP, IIM INDORE
Recap Session 3
•Numerical exercise:
• Terminal value contributes a large proportion of value to the Enterprise value
• Forecasts are expressed as a percentage of sales or as a turnover ratio

•Synergy differences would exist between two strategic buyers

• Different value for the same target firm for different strategic buyers

•Approaches for estimating Terminal Value: Multiples approach

•Capital Cash Flow
• Assignments:
• Appropriate discount rate
• CCF of Corus
• How to estimate the growth rate for the intermediate period (revenue growth rate) and the stable growth rate?
Capital Cash Flow (CCF) Approach
Projections 2022 2023
Sales 25,000.00 35,000.00
COGS (excluding depr.)
Gross Profit
5,400.00
19,600.00
7,700.00
27,300.00
CCF Example
SG&A 15,000.00 20,000.00 •Capex is 150% of Depreciation

EBITDA 4,600.00 7,300.00 •Change in working capital is 2.5%

of Sales
Depreciation 500.00 700.00
•Capital cash flows?
Amortization 50.00 70.00
•CCF vs. FCF?
EBIT 4,050.00 6,530.00
Interest exps. 500.00 900.00
EBT 3,550.00 5,630.00
Taxes (35%) 1,242.50 1,970.50
Net Income 2,307.50 3,659.50
Capital Cash flows and Free Cash Flows
Capital Cash Flow 2022 2023 Free Cash Flow 2022 2023
EBIT 4050 6530 EBIT 4050 6530
Less. Hypothetical
Less. Actual Taxes 1242.5 1970.5 Taxes 1417.5 2285.5
Nopat 2807.5 4559.5 Nopat 2632.5 4244.5
Add. Dep 500 700 Add. Dep 500 700
Add. Amortization 50 70 Add. Amortization 50 70
Less. Capex 750 1050 Less. Capex 750 1050

Less. Change in NWC 625 875 Less. Change in NWC 625 875
Capital Cash Flow 1982.5 3404.5 Free Cash Flow 1807.5 3089.5
Free Cash Flows + Interest tax shield = Capital Cash Flow
Capital Cash Flows: EBIT and NI route
Capital Cash Flow 2022 2023 Capital Cash Flow 2022 2023

EBIT 4,050.00 6,530.00 Net Income 2,307.50 3,659.50

Less. Actual Taxes 1,242.50 1,970.50 Add. Interest 500.00 900.00
Nopat 2,807.50 4,559.50
Add. Dep 500.00 700.00 Add. Dep 500.00 700.00
Add. Amortization 50.00 70.00 Add. Amortization 50.00 70.00
Less. Capex 750.00 1,050.00 Less. Capex 750.00 1,050.00
Less. Change in NWC 625.00 875.00 Less. Change in NWC 625.00 875.00
Capital Cash Flow 1,982.50 3,404.50 Capital Cash Flow 1,982.50 3,404.50
Discount rate for CCF
•A version of WACC since CCF accrues to Debt and Equity Investors
•Since the tax shields are included in the cash flows (CCF), the pre-tax WACC could be considered
Pre-tax WACC = [(D/V) * kd ] + [(E/V) * ke]
•Absence of a reliable D/V and E/V ratios for the forecast period
• Changing leverage ratio

•Theoretically, Pre-tax WACC is Ka

 Cash Flow Valuation Techniques
Earning Before Interest and Taxes ( EBIT)

Plus Depreciation, Less Capex, Less Change in Working Capital

Operating Cash Flow

Subtract Actual Taxes

Subtract Hypothetical Taxes
Tax Rate
Tax Rate X ( EBIT)
X (EBIT – Interest)

Capital Cash Flow Free Cash Flow

Discount at Expected Asset Return Discount at Weighted Average Cost of

or Pre-tax WACC Capital
Summary of Capital Cash Flow Approach
•Capital Cash Flows to Firm
• Tax benefit (due to interest) included in the Cash flows
•CCF = EBIT – Actual Taxes + Depreciation (and other non-cash Charges) – Capex –
Change in NWC
•Discount rate: Pre-tax rate corresponding to the riskiness of the assets of the firm
◦ Discount rate: Pre-tax WACC or E(R) on Assets
◦ Theoretically, Pre-tax WACC equals E(R) on Assets
◦ E(R) = Rf + 𝑏!""#$ (Rm- Rf)
CCF vs. FCF
•Both approaches value the entire firm
•Difference: Hypothetical Tax vs. approx. Actual Tax
•CCF more appropriate when
• When debt is forecasted in dollar amounts (NOT as a D/E ratio targeted by a firm)
• When capital structure changes over time
•Discount rate doesn’t have to be re-estimated every period
◦ E(R) does not change when capital structure changes (in case of CCF), while, WACC has be re-estimated
every period
◦ With changing capital structure weights, Ke and Kd have to be re-estimated every period as well – This
issue is mitigated by using CCF
Choosing the Right Model: Summary
•Use FCFF
• For firms which are expected to maintain a target capital structure
• Can assume constant WACC
• Can have WACC! for forecast period, WACC" for TV (if the capital structures
in the two periods are different)
•Use Capital Cash Flows (or APV – ref. Airthread Valuation in Finance II)
• For firms which are expect to change the leverage over time
• The discount rate (Expected Asset Return) does not change dramatically over
time.
Value of a Target Firm

Value created for Value created for

Target Co. shareholders Acquirer’s shareholders

Standalone Acquisition Price Value with

Value Synergies

Potential Range for Acquisition

Price
Value of a Target Firm

Value created for Value created for

Target Co. shareholders - $500 mn Acquirer’s shareholders - $750 mn

Standalone Acquisition Price Value with

Value - - $5.75 bn Synergies -
$5.25 bn $6.5 bn

Potential Range for Acquisition

Price
Valuation of Corus PLC.
Case Information
•Tata Corus deal was first announced in October 2006, and finalized in early 2007.
•A large portion of the transaction was funded by raising debt from different sources.
•Tata Steel had crude steel production of 5.3 million tons across India and South-East Asia.
•Corus had a crude steel production of 18.2 million tons in 2005.
•The combined entity became the fifth largest steel company in the world.
•Acquisition Debt, and other case facts about the debt
• D/E ratio of 16:84 in normal course of business and after the projection period
• Pre-tax cost of debt of 6% when D/E is 16:84

•Beta of Corus – 1.16, and expected stable growth rate – 2%

Relative Valuation: Multiples Approach
Relative Valuation
Also called the Multiples approach
◦ Estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common
variable like earnings, cash flows, book value or sales.

Law of One Price

◦ How the market prices “similar” or ‘comparable” assets.

Precedent Transaction Analysis / Transaction Comparables

◦ Recent sale transactions of comparable companies

Ref. Damodaran on Valuation by Aswath Damodaran, 2nd edition, Wiley Finance

Approach
Identical asset
◦ A group of comparable / similar assets
◦ Identical / similar transactions

Search and Select - Group of comparable companies

◦ Key factors – Similar Risk and Similar Growth expectations
◦ SIC / NIC – Industry classification codes
◦ Business Description (Characteristics of subject’s business)
◦ Size, geography, Degree of Diversification, etc.
◦ Market positions, life cycle stages, customer bases, etc.
◦ Pure play companies

Note of Caution: Do not select companies based on multiples

Peer group for Bajaj Auto India
An Illustration: Ref. Excel
References
Ruback, R.S. (1995). An Introduction to Cash Flow Valuation Methods. HBS No. 9-295-155. Boston, MA:
Harvard Business School Publishing
Leuhrman, T.A. (2009). Corporate Valuation and Market Multiples. HBS No. 9-206-039. Boston, MA:
Harvard Business School Publishing.
Rosenbaum, J and Pearl, J. (2013). Discounted Cash Flow Analysis. Investment Banking: Valuation,
Leveraged Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Session 5. DCF and Multiples Approach:
Part IV
PGP, IIM INDORE
Recap Session 4
•Capital Cash Flows
• Appropriate discount rate – Expected return on assets, Ka=Rf + ba*MRP

•Capital Cash Flows = Free Cash Flows + Interest Tax shields

•Illustration: Valuation of Corus
•Standalone value, value with synergies and the zone of possible agreement.
Relative Valuation: Multiples Approach
Relative Valuation
Also called the Multiples approach
◦ Estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common
variable like earnings, cash flows, book value or sales.

Law of One Price

◦ How the market prices “similar” or ‘comparable” assets.

Precedent Transaction Analysis / Transaction Comparables

◦ Recent sale transactions of comparable companies

Ref. Damodaran on Valuation by Aswath Damodaran, 2nd edition, Wiley Finance

Approach
Identical asset
◦ A group of comparable / similar assets
◦ Identical / similar transactions

Search and Select - Group of comparable companies

◦ Key factors – Similar Risk and Similar Growth expectations
◦ SIC / NIC – Industry classification codes
◦ Business Description (Characteristics of subject’s business)
◦ Size, geography, Degree of Diversification, etc.
◦ Market positions, life cycle stages, customer bases, etc.
◦ Pure play companies

Note of Caution: Do not select companies based on multiples

Peer group for Bajaj Auto India
An Illustration: Ref. Excel
 Multiples
Market Value of the Operating Assets of Firm
Market Value of the Firm Enterprise Value (EV) = Market Value of Equity
Firm Value (FV) = Market Value of Equity + + Market Value of Debt - Cash
Market Value of Debt Market Value of Equity

𝑊ℎ𝑎𝑡 𝑦𝑜𝑢 𝑎𝑟𝑒 𝑝𝑎𝑦𝑖𝑛𝑔 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑎𝑠𝑠𝑒𝑡

𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑒 =
𝑊ℎ𝑎𝑡 𝑦𝑜𝑢 𝑎𝑟𝑒 𝑔𝑒𝑡𝑡𝑖𝑛𝑔 𝑖𝑛 𝑟𝑒𝑡𝑢𝑟𝑛

Revenues Earnings Cash Flows Book Values

a. Sales a. Net Income (Earnings to Equity) a. To firm: FCF a. Book value of Equity
b. Revenue drivers b. EBIT (To enterprise or Firm) b. To equity b. Firm
• Customers c. EBITDA (To enterprise or Firm) • FCFE • Book Value of Equity + Book
• Subscribers • Net Income + Depreciation Value of Debt
• Capacity – Metric Tonne c. Enterprise
• Book value of Equity + Book
Value of Debt - Cash

Ref. Damodaran on Valuation by Aswath Damodaran, 2nd edition, Wiley Finance

Conventional usage
•Young growth firms, negative earnings
• EV/Revenues, Price/Revenues
• Price refers to equity value, EV – Enterprise value.

•New companies with small sales and negative profits – Dotcoms in late 1990s
• EV/Website hits, EV/Unique visitors, EV/No. of Subscribers

•Retailing
• EV/Revenues – Firms have similar operating margins

•EV/Capacity
• Oil and Gas (Reserves – Barrels), Steel, Cement (EV/Tonne or Metric Tonne)
Precedent transactions analysis
•Identifying precedent transactions (transaction comps / transaction multiples)
• Deals in the same industry as the target firm
• Products/Services, Geography
• Successfully completed transactions (not pending or withdrawn deals)
• Similar deal characteristics: Strategic or Financial Acquirers, Domestic vs. Cross border

•How are transaction multiples different from trading multiples

• Precedent transactions incorporate premium (control & synergy) in the multiples paid

•Collate the key deal multiples

• EV/EBITDA, EV/SALES, Price/EPS, Market Cap/Book-value
• Average, median and range of each multiple
HP-Compaq Deal: Precedent Jumbo
Transactions
Announcement Transaction value
date (mmddyy) Target name Acquirer name (USD Million) EV/Sales EV/EBIT

09-04-2001 Compaq Computer Hewlett-Packard 25263 0.62 13.51

10/16/2000 Texaco Chevron 42872 0.78 10.25

09/13/2000 JP Morgan and Co. Chase Manhattan 33555 1.72 10.48

Deutsche Telekom
07/24/2000 Voice Stream Wireless AG 29404 12.14 nm
05-02-2000 Best Foods Unilever PLC 25065 2.41 15.44

01-10-2000 Time Warner America Online 164746 6.03 27.31

Sun Microsystems Case
Sun Microsystems: Discussion
◦ 1. What rate of return should Oracle require on the acquisition?
◦ 2. Forecast the base case cash flows, estimate the terminal value (using two approaches – growing
perpetuity and multiples) and the discount rate.
◦ 3. How much is Sun worth as a stand-alone company? What is the enterprise value of Sun Microsystems
and what is the equity value? Conduct a sensitivity analysis for the target's value
◦ 4. Conduct a multiples analysis to value Sun Microsystems.
◦ 5. Identify the synergies, incorporate them in the valuation, and estimate the effect of synergies on
enterprise value.
References
Ruback, R.S. (1995). An Introduction to Cash Flow Valuation Methods. HBS No. 9-295-155. Boston, MA:
Harvard Business School Publishing
Leuhrman, T.A. (2009). Corporate Valuation and Market Multiples. HBS No. 9-206-039. Boston, MA:
Harvard Business School Publishing.
Rosenbaum, J and Pearl, J. (2013). Discounted Cash Flow Analysis. Investment Banking: Valuation,
Leveraged Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Session 5 and 6. Sun Microsystems and Deal
Pitch Book
PGP, IIM INDORE
Sun Microsystems Case
Sun Microsystems: Discussion
◦ 1. What rate of return should Oracle require on the acquisition?
◦ 2. Forecast the base case cash flows, estimate the terminal value (using two approaches – growing
perpetuity and multiples) and the discount rate.
◦ 3. How much is Sun worth as a stand-alone company? What is the enterprise value of Sun Microsystems
and what is the equity value? Conduct a sensitivity analysis for the target's value
◦ 4. Conduct a multiples analysis to value Sun Microsystems.
◦ 5. Identify the synergies, incorporate them in the valuation, and estimate the effect of synergies on
enterprise value.
Estimating Components of Cash
Flows
Growth: Intermediate period and Stable
Fundamentals
◦ How much the firm is investing in new projects
◦ What returns these projects are making for the firm

Reinvestment Rate * ROIC = g

◦ Where Reinvestment Rate is: (Capex + Change in WC – Dep) / Nopat
◦ Where ROIC is = NOPAT/Invested Capital
◦ Where Invested Capital = Debt + Equity (Excluding non-operating cash & investments)
An illustration
•EBIT of a company is 232 mn and Nopat is 173 mn
•Capex is 110 mn, Depreciation is 60 mn, new investment in working capital is 52 mn
• Book value of debt and equity is 399 mn and 445 mn, respectively
•What is the expected growth (%) in the earnings of the company?
•Note: Depreciation as % of Capex indicates that is a growing company
!"#$%&!'"()$ *( +,! -.$#/$0*"1*2(
•𝑅𝑒𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 =
+2#"1
+2#"1
•𝑅𝑂𝐼𝐶 =
.$31&456*17 -!"8'
An illustration
•EBIT of a company is 232 mn and Nopat is 173 mn
•Capex is 110 mn, Depreciation is 60 mn, new investment in working capital is 52 mn
• Book value of debt and equity is 399 mn and 445 mn (net of cash), respectively
•What is the expected growth (%) in the earnings of the company?
•Note: Depreciation as % of Capex indicates that is a growing company
99:&;<-=:
•𝑅𝑒𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒 = = 58.95%
9>?
9>?
•𝑅𝑂𝐼𝐶 = = 20.50%
?@@&AA;
•Expected growth rate = 58.95% * 20.5% = 12.08%
Revenues
•Historical trend
• To check the effect of changing size
• To be triangulated with the following

•Management Projections: Management Case

• Annual Reports

•Consensus estimates, Equity research reports, Industry report (sector outlook), economic
outlook
•Expected Market size and the market share
• To consider market share gains/declines, product mix changes, demand shift, etc.
Growth Rate Estimation
Analysts forecasts: Bloomberg and Thomson Reuters (now Refinitiv Eikon), other public sources.
Industry reports
◦ CMIE Industry Analysis Service (http://industryoutlook.cmie.com/)
◦ Crisil Reports (http://www.crisil.com/research/industry-information-service.html)
◦ Business Monitor International (BMI)
◦ Euromonitor International (http://www.euromonitor.com/india)
Assignment: Other Projections
•COGS and SG&A
•Depreciation and Amortization
•Capex and Working Capital
Projections
•Revenue
• Generally year-on-year growth rates considered
• Segment wise projections may be preferred

•COGS and SG&A could be estimated as percentage of sales

• Historical COGS as % of Sales (and SG&A as % of Sales), or Consensus estimates (if available)
• If there is significant improvement expected then the percentages may be lower than historical
• Industry averages may be considered in some cases

•Depreciation and Amortisation

• Percentage of Sales or Capex based on Historical levels
• Alternatively, build a PP&E Schedule (Fixed Asset Schedule)
• Based on current level of Fixed Assets, Projected Capex and associated depreciation rate
Capital Expenditure and Working Capital
Assumptions about net capital expenditures can therefore never be made independently of
assumptions about revenue growth in the future.
◦ Estimate Asset Turnover or Percentage of Sales
◦ Sales / Total Fixed Assets, Or, estimate CAPEX as % of Sales
◦ Based on historical levels or Industry average
◦ Consistent with growth rate assumptions

Net Working Capital

◦ Estimate NWC by looking at non-cash working capital as a proportion of revenues
◦ Industry average – a guiding figure
• Alternatively, forecast individual components
◦ DSO, DIH, DPO
 Projection Period and Growth rate
• Projection Period
• Strategy of Exit: Investment Horizon (apply exit multiple in such cases)
• Stability in Growth – Terminate the projections when company reaches stability in growth

• Stable Growth, 2-stage model

• Example: If your firm is large & growing at a moderate rate
• Indicative stages: Stage 1-Projection period with high growth rate tapering down to long-term growth rate. Stage 2 - TV estimation
assuming stable growth
• Most likely there are barriers to entry with a finite life (e.g. patents, etc.)

Stable Growth, 3-stage model:

◦ Example: If your firm is small & growing at a very high rate. Or your firm has significant barriers to entry into the business The
company has firm characteristics that are very different from the norm.
◦ Indicative stages:
• Stage 1: Projection period with abnormal growth rate
• Stage 2: Projection period with high growth tapering down to long-term growth rate
• Stage 3: TV estimation assuming stable growth
References
Ruback, R.S. (1995). An Introduction to Cash Flow Valuation Methods. HBS No. 9-295-155. Boston, MA:
Harvard Business School Publishing
Leuhrman, T.A. (2009). Corporate Valuation and Market Multiples. HBS No. 9-206-039. Boston, MA:
Harvard Business School Publishing.
Rosenbaum, J and Pearl, J. (2013). Discounted Cash Flow Analysis. Investment Banking: Valuation,
Leveraged Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
Investment Valuation by Aswath Damodaran, 2nd edition, Wiley Finance
Bruner, R.F. (2002). The M&A Pitch Book: Proposed Acquisition of Heller Financial by United Technologies
Corporations. Darden ID: UV2486. Charlottesville, VA: Darden Business Publishing.
Session 8 and 9. Fundamentals of
Leveraged Buyouts and RJR Nabisco
PGP, IIM INDORE
Leveraged Buyouts
•A leveraged buyout (LBO) is the acquisition of a company, division, business, or collection of assets
(“target”) using debt to finance a large portion of the purchase price

•In a traditional LBO, debt has typically comprised 60% to 70% of the financing structure, with equity
comprising the remaining 30% to 40% (equity contributed by financial sponsors)

•Historically, financial buyers have sought a 15-20%+ annualized return

•Exit the investment generally within five years: IPO, Sale to a strategic buyer, or another PE Fund
(secondary LBO)

•When undertaken by the incumbent managers are called MBOs – Management Buyouts

•Companies with stable and predictable cash flow, as well as substantial assets, generally represent
attractive LBO candidates due to their ability to support larger quantities of debt
LBOs
LBOs by Financial Buyers
◦ PE firms – also referred to as financial sponsors
◦ Blackstone, KKR, Apollo Global Management, Carlyle Group, TPG Capital, Silver Lake Partners
◦ Term “financial sponsor” not only refers to traditional private equity (PE) firms, but also, merchant
banking divisions of investment banks, hedge funds, venture capital funds
◦ Expertise lies in arranging the finance
◦ KKR – RJR Nabisco
◦ Apax Partners and Hicks Muse – Yell Group

LBOs can also be undertaken by Strategic buyers

◦ Have assets/expertise to combine with the target firm (synergies)
◦ Tata – Corus
◦ Dell-EMC Buyout - $ 67 Billion (Completed in 2016)
◦ American Cable Co. – Airthread Connections
Ideal LBO Targets
Proven Demand for product - Steady Cash flows
Mature Industry: Retailing, Textiles, Food processing, apparel, soft drinks
◦ Minimal discretionary capex
Significant debt capacity – low D/E
Potential operating improvement
Strong management team
◦ Strong relationships with key customers and suppliers
◦ Experience enables opportunities for trimming costs
Which companies are not ideal LBO targets?
◦ High Tech companies
◦ Shorter history, greater risk
◦ Fewer Leveragable assets
◦ Companies that need huge investments in Capex, R&D
LBO Value Drivers: How do LBOs
Generate Returns?
Debt repayment: INTEREST TAX SHIELDS and Deleveraging
Active monitoring by Financial buyers (Financial Discipline)
Operating improvement
◦ Consolidate or reorganize production facilities
◦ Improve inventory control & accounts receivables management
◦ Trim employment
◦ Improve product quality – mix – service
◦ Extract better terms from suppliers
Cut Investments – Capex and R&D
◦ Reduce discretionary Capex (not maintenance capex)
Sell assets (not related to the core business)
 Impact of Leverage on Return to Shareholders
All-Equity 50% 20% Equity/80%
Purchase Equity/50% Debt
($Millions) Debt ($Millions)
($Millions)
Purchase Price $100 $100 $100
Equity (Cash Investment by Financial $100 $50 $20
Sponsor)
Borrowings 0 $50 $80

Earnings Before Interest and Taxes (EBIT) $20 $20 $20

Interest @ 10%

Income Before Taxes

Less Income Taxes @ 40%

Net Income

After-Tax Return on Equity (ROE)

 Impact of Leverage on Return to Shareholders
All-Cash 50% Cash/50% 20% Cash/80%
Purchase Debt Debt
($Millions) ($Millions) ($Millions)
Purchase Price $100 $100 $100
Equity (Cash Investment by Financial $100 $50 $20
Sponsor)
Borrowings 0 $50 $80

Earnings Before Interest and Taxes (EBIT) $20 $20 $20

Interest @ 10% 0 $5 $8

Income Before Taxes $20 $15 $12

Less Income Taxes @ 40% $8 $6 $4.8

Net Income $12 $9 $7.2

After-Tax Return on Equity (ROE) 12% 18% 36%

Case analysis
Case Analysis
What were the initial bids?
◦ Operating Strategies under each bid?

Which method of DCF valuation could be used to value RJR Nabisco?

What is the value of RJR Nabisco?
Is Cash flow available for capital payments equal to Capital Cash Flow?
If CCF approach is used to evaluate RJR Nabisco’s Value under each strategy, what is the cost of
capital?
Value under:
◦ Pre-bid Strategy?
◦ Management Group Strategy?
◦ KKR Strategy?
Debt Repayment
Characteristics of LBO Debt (gen. in large LBOs)
◦ Substantial debt pay-down from asset sales in initial years
◦ Debt with different maturity structure and amortization schedule
◦ Part of debt matures early, and part matures later, there fore there is no large burden in any year
◦ Not all debt attract principal repayments in the intermediate years (i.e., some debt with bullet
payments)
◦ Debt with cash and non-cash interest components
◦ Non-cash portion of interest postpones the cash flow
What was the eventual outcome?
Summary Of Bids By The Management Group and KKR
THE MANAGEMENT GROUP KKR

Date Cash Pref. Stock Conv. Pref. Total Date Cash PIK Pref. Conv. Debt Total
Stock Stock

1. Oct. 19 Not $ 75 1. Oct. 24 $ 70 Not Not $ 90

Terms specified Specified Specified
2. Nov. 3 $ 84 $ 4 $ 4 92

3. Nov. 18 90 6 4 100 2. Nov. 18 75 $ 11 $8 94

4. Nov 29 88 9 4 101 3. Nov. 29 80 17 9 106

5. Nov 30 84 20 4 108 4.Nov. 30 80 18 10 108

6. Nov. 30 84 24 4 112 5. Nov. 30 81 18 10 109

Eventual outcome
•KKR and Management group’s bids were not substantially different
• Valued at $108 by the financial advisors of the Special committee

•KKR’s bid had merits:

• KKR bid had more equity – 25% vs. 15% (management group)
• KKR would retain many of the food business assets
• Fewer PIK securities in KKR’s bid
• KKR would provide benefits for terminated employees, the management group would not

•Further negotiations would have led the bidders to withdraw

• Approx. 100% premium on the pre-bid share price

•The committee recommended the KKR bid to the Board, and the merger agreement with KKR
was executed
Eventual Outcome
Winner: KKR – Winner’s curse
Loser: RJR –ever since
◦ RJR GOES FROM ASHES TO ASHES
◦ (http://archive.fortune.com/magazines/fortune/fortune_archive/2003/10/13/350888/index.htm
◦ LBO debt was not completely paid until 1999
◦ Philip Morris (incl. Kraft – Food Business) took benefit of this opportunity
◦ RJR was occupied paying LBO debt
◦ Phillip Morris ploughed back the money in the business and beefed up its advertising
◦ “Phillip Morris toyed with the competitor like a cat with a wounded mouse”
◦ Slashed prices in 1993
LBO Return Analysis
Returns Analysis – Internal Rate of Return and Cash Return
•Internal rate of return (IRR): the primary metric by which sponsors gauge the attractiveness of a
potential LBO
• The total return on a sponsor’s equity investment
• Including any additional equity contributions made, or dividends received, during the investment
horizon

•Cash Return: Sponsors also examine returns on the basis of a multiple of their cash investment
•Assuming a sponsor contributes $300 million of equity and receives equity proceeds of $1,000
million at the end of the investment horizon:
• The cash return is 3.3x (assuming no additional investments or dividends during the period)
• Cash return approach does not factor in the time value of money

17
Return Analysis
•The equity contribution made by the Sponsor is $2100 mn in 2012
•The company is expected to reach pre-acquisition level of debt in 7 years

Current
All figures In USD Million Year Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
2012 2013 2014 2015 2016 2017 2018 2019
Sponsor's equity investment -2100
Projected Debt 3445.1 3201.5 2922.6 2609.4 2263.9 1892.9 1500
Cash and Cash Equivalents 0 0 0 0 0 0 5.8
EBITDA 779.4 826.1 867.4 902.1 929.2 957.1 985.8

•The sponsor envisages the exit at Year 5, what is the IRR and the Cash-on-Cash return if the exit
multiple is 8x – EV/EBITDA?
 Return Analysis
•If the exit is expected in year five, and the exit multiple is 8x (EV/EBITDA), what is the IRR?

Current Year Year 1 Year 2 Year 3 Year 4 Year 5

2012 2013 2014 2015 2016 2017
Initial Investment -$2,100.00
EBITDA 779.4 826.1 867.4 902.1 929.2
Exit EBITDA Multiple 8
Enterprise Value at Exit 7433.6
Return Analysis
Current Year Year 1 Year 2 Year 3 Year 4 Year 5
2012 2013 2014 2015 2016 2017
Initial Investment -$2,100.00
EBITDA 779.4 826.1 867.4 902.1 929.2
Exit EBITDA Multiple 8
Enterprise Value at Exit 7433.6
Less: Debt 2263.9
Add: Cash and Cash equivalent 0

Equity Value at exit (Investment at Entry) -$2,100.00 0 0 0 0 5169.7

Internal rate of return (IRR) 19.74%
Cash-on-cash return 2.46
References
•Rosenbaum, J and Pearl, J. (2013). LBO Analysis. Investment Banking: Valuation, Leveraged
Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
•Ruback, R. (2006). RJR Nabisco. HBS No. 9-289-056. Boston, MA: Harvard Business School
Publishing.
Session 10. Leveraged Buyouts and
Hertz Buyout
PGP, IIM INDORE
Case Analysis: Hertz Buyout
•Ownership changes
•Current Industry dynamics
•Rationale for considering the strategic options for the business segment
•The structure of the deal
• Rationale for the Opco/Propco Structure, key advantages

•Is the target an ideal LBO Candidate?

•The returns expected by the Consortium considering their initial investment
• If they exit the investment at the end of 2010
Ref. Excel
References
•Rosenbaum, J and Pearl, J. (2013). LBO Analysis. Investment Banking: Valuation, Leveraged
Buyouts, and Mergers and Acquisitions (pp. 251-311). New Jersey, USA: John Wiley & Sons, Inc.
•Chaplinsky, S., & Marston, F. C., 2016. Bidding for Hertz: Leveraged Buyout. Darden Business
Publishing, UV1056. Charlottesville, VA: Darden Business Publishing.
Session 13 and 14. Deal Consideration
Structure: Cases Studies
PGP, IIM INDORE
Ambuja Cements and Holcim India
Merger
Deal Terms on Payment
Part I: ACL acquired a 24% stake in Holcim (India) Pvt. Ltd. for INR 35 billion in Cash
Part II: HIPL merged with ACL
◦ Stock payment, 10 shares of ACL for every 74 shares of HIPL

The structure of ownership after the transaction

◦ How many shares will ACL issue to the shareholders of HIPL now?
◦ How many shares will ACL have (shares outstanding) after the transaction?
◦ How many shares would Holcim effectively own in the merged entity after the merger?
Ambuja Cements and Holcim India Merger
•How many NEW shares will ACL issue to the shareholders of HIPL for the Second Part of the
Merger?
• To consider the original ACL Shares O/S
• To consider the original HIPL Shares O/S

•New shares issued by ACL for the second part of the merger.
•Calculate the total shares outstanding for ACL after the merger?
Ambuja Cements and Holcim India Merger
•Calculate the total shares outstanding for ACL after the merger?
• ACL Shares O/S
• Add. New shares issued by ACL
• Less. HIPL’s shareholdings in ACL

•How many shares would Holcim Own in ACL?

• Holcim owns 40.79% in ACL before the transaction
• Add. New shares issued by ACL
• Percentage owned by Holcim = 61.396%
Exchange ratio
•Swap ratio = exchange ratio = number of shares of the buying company for each share of the
target company
•Exchange ratio in terms of prices paid
•Exchange ratio = Value paid per Share of Target Firm (with control premium and part of the
synergies) / Value per Share of Bidding Firm
•If the exchange ratio is set too high, there will be a transfer of wealth from the bidding firm’s
stockholders to the target firm’s stockholders, and vice-versa.
Value Neutral Exchange ratio
•Exchange ratio based on the share prices before the deal
•ER = P_Target / Price_Bidder
•Under the conditions of no synergy and no other impact on fundamentals, this ratio will retain
value for the two parties
• No party is better off or worse off

•To consider share prices before the deal: the most recent prices, and the average over a period
Example
Focal Exchange ratio based on the share prices
Details Fleet Financial (Bidder) Bank Boston (Target)
Share Prices
2/26/1999 42.94 40.44
1/29/1999 44.31 36.94
12/31/1998 44.69 38.94
11/20/1998 41.69 41.63
10/30/1998 40.69 36.81

ER_2/26/1999 0.94

ER_11/20/1998 0.9985
Mellon Financial and the Bank of New
York
•Refer to the existing outstanding shares held by the current shareholders of Mellon Financial
(MEL) and the Bank of New York (BNY). Given the exchange ratio which is agreed upon, and
assuming that there are no synergies and there is no other reason for fundamental change in
market value of the equity of the two companies, calculate the following:
• What exchange ratio has been proposed in the transaction?
• How would BNY shareholders own 63% of the new firm?
• What are the number of shares that would be held by BNY and MEL shareholders in the new company?
• If there are no synergies (and there is no change in the market values), what is the expected share price of
the new company?
• Is this exchange ratio fair for MEL shareholders? What is the wealth effect of the proposed exchange
ratio (absent synergies)?
• Who benefits from this?

•Excel Template
Mellon Financial and the Bank of New
York
•Absent synergies, what is the neutral (i.e., value neutral / zero premium) exchange ratio that would not
make any party worse-off?
• Test if the wealth is retained
• If the neutral exchange ratio as mentioned above is offered, what will be the number of shares held by BNY and
MEL shareholder in the NewCo, and what will be the share price?
• Is there any other alternative ratio that is value neutral?
• Test if the wealth is retained

•Why was BNY not satisfied with the value neutral exchange ratio?
• Test the impact of the ratio on the post-deal EPS
• What is the impact of the value-neutral exchange ratio on the post-deal earnings attributable to the legacy
shareholders of MEL and BNY? Hint: Consider Q4 2007 earnings.

•What is the impact of the proposed ER (0.9434:1) on the post-deal EPS?

•If there are no synergies, then what exchange ratio would hold EPS constant (EPS neutral exchange
ratio)?
• Impact on shareholder wealth
References
Framework for Structuring the Terms of Exchange: Finding the “Win-Win” Deal. Applied Merger
And Acquisition, by Robert F. Bruner, Wiley Finance.
Mohanty, P., Stephen, T. and Mishra, S. (2016). Ambuja Cements and Holcim India Merger. HBS
Product No. W16572. Ontario, CA: Ivey Publishing.
Baldwin, C. Y. and Taliaferro, R.D. (2010). Mellon Financial and the Bank of New York. HBS No.
9208129. Boston, MA: Harvard Business School Publishing.
Session 13. Deal Design: Consideration
Structure
PGP, IIM INDORE
Agenda
•Exchange ratio: number of shares of the buying company for each share of the target company
•Buyer’s upper bound of exchange ratios
•Target’s lower bound of exchange ratios
•Zone of possible agreement
Swap (exchange) ratio
•In October 2019, Bandhan Bank and Gruh Finance completed their merger
• Exchange ratio: 568 shares of Bandhan Bank for 1000 shares of Gruh Finance
• The deal would help Bandhan Bank diversify its loan portfolio

•In Nov, 2014, Kotak Mahindra Bank and ING Vysya Deal announced a mega merger in the
banking sector
• Share exchange ratio of 725 equity shares of Kotak Mahindra Bank Ltd. for every 1,000 equity shares of
ING Vysya Bank Ltd
• Deal value INR 15000 crores

•Swap ratio = exchange ratio = number of shares of the buying company for each share of the
target company
FRAMEWORK FOR STRUCTURING THE TERMS OF
EXCHANGE IN STOCK-FOR-STOCK DEALS
Deal Boundaries: A Model For Critically Assessing
Exchange Ratios
•Deal boundaries are the limits within which a mutually agreeable deal (“win-
win” deal) is possible, that is, the consideration offered is:
• Above the minimum acceptable price for the seller,
• Below the maximum acceptable price for the buyer.
•Key Foundation of Deal Boundary Models: Neither the buyer nor the seller
wants to be poorer after the deal
• Buyer: Set a maximum exchange ratio below which the buyer will be willing to acquire the
target.
• Target: Have a minimum exchange ratio above which it will be willing to be acquired.
•The maximum and minimum depend on the estimated value of the new firm
arising from the deal (“Newco”).
Deal Boundaries: A Model For Critically Assessing
Exchange Ratios
•To find Exchange Ratios
• ER1= Maximum acceptable exchange ratio (buyer shares per target share) from the buyer’s
viewpoint.
• ER2= Minimum acceptable exchange ratio (buyer shares per target share) from the
target’s viewpoint.
•Where, inputs are:
• P1= Price per share of the buyer today, before the transaction.
• P2= Price per share of the target today.
• S1= No. of buyer shares outstanding today, before the transaction.
• S2= No. of target shares outstanding today.
•DCF12= Discounted cash flow value of the equity of the combined firm.
Formulas for the Deal Boundaries (DCF Approach):

Particulars Buyer’s Maximum Target’s Minimum

Acceptable Exchange Ratio Acceptable Exchange
Ratio
Shares for shares ER1 =!"#$%&'$($ ER2 =
'%($
'$(% !"#$%&'%(%
An Illustration
Particulars Inputs •An important assumption here is that the Newco
will have a DCF value of $11,000.
Buyer’s share price P1 = $ 60 •What is the buyer’s maximum acceptable exchange
ratio? What is the target’s minimum acceptable
exchange ratio?
Target’s share price P2 = $ 40
!"#$%&'$($ '%($
ER1 = ER2 =
Buyer’s share S1 = 100 '$(% !"#$%&'%(%

outstanding
Target’s share S2 = 100 •ER1= 0.83
outstanding
•ER2= 0.57
DCF of Newco DCF12 = $ 11,000
•If the DCF_12 is 9000, then the exchange ratios are?
 Estimates of Maximum And Minimum Exchange Ratios
Used in Example: Results Based on Equity DCF Value of
Newco
DCF12 Maximum Acceptable ER1 Minimum Acceptable ER2
$7,000 0.17 1.33
$8,000 0.33 1
$9,000 0.5 0.8
Break even
DCF $10,000 0.67 0.67
$11,000 0.83 0.57
$112,000 1 0.5
$13,000 1.17 0.44

Note: The Exchange ratios (ER1 and ER2) are equal at the breakeven DCF.
Estimates of Maximum And Minimum Exchange Ratios
Used in Example: Results Based on Equity DCF Value of
Newco
DCF12 Maximum Acceptable ER1 Minimum Acceptable ER2
$7,000 0.17 1.33
$8,000 0.33 1
$9,000 0.5 0.8
$10,000 0.67 0.67
$11,000 0.83 0.57
$112,000 1 0.5
$13,000 1.17 0.44

Zone of possible agreement for a mutually beneficial deal.

Exchange ratio (to be discussed)
•Exchange ratio in terms of prices paid
•Exchange ratio = Value paid per Share of Target Firm (with control premium and part of the
synergies) / Value per Share of Bidding Firm
•If the exchange ratio is set too high, there will be a transfer of wealth from the bidding firm’s
stockholders to the target firm’s stockholders, and vice-versa.
Neutral Exchange ratio (to be discussed)
•Exchange ratio based on the share prices before the deal
•ER = P_Target / Price_Bidder
•Derived from the following:
• P_Target * S_Target = Price_bidder * ΔS_bidder

•To consider share prices before the deal: the most recent prices, and the average over a period
Example (to be discussed)
Focal Exchange ratio based on the share prices
Details Fleet Financial (Bidder) Bank Boston (Target)
Share Prices
2/26/1999 42.94 40.44
1/29/1999 44.31 36.94
12/31/1998 44.69 38.94
11/20/1998 41.69 41.63
10/30/1998 40.69 36.81

ER_2/26/1999 0.94

ER_11/20/1998 1.00
References
Framework for Structuring the Terms of Exchange: Finding the “Win-Win” Deal. Applied Merger
And Acquisition, by Robert F. Bruner, Wiley Finance.
Session 15. Risk Management: Use of Caps,
floors and Collars
Case: The MCI Takeover Battle: Verizon
Versus Qwest
PGP, IIM INDORE
Risk Management: Price Protection
Mechanisms
Pre-Closing Risks in M&A Deals: Payment Terms
Fixed Exchange Ratio Deal
As the buyer’s share price rises or falls, shareholder of the target feels the value of its expected
payment in shares grow and shrink.
Uncertainty about how much the deal is really worth.
Value of an Unprotected Bid
Fixed Exchange Ratio Bid How the Value of the Bid Varies with Buyer´s Stock Price
P_Buyer - $100
P_Seller - $ 75
Base case ER : 1:1 $250

$200
The value of the target’s

per Target Share

Value of the Bid
share price is pegged to the $150
value of the buyer’s share ER=1.0
price (post-announcement, $100

before closing) $50

$-
$- $50 $100 $150 $200
Buyer´s Stock Price
Managing Pre-Closing Risks associated with
payment terms: Consideration Structure with
Floors, Caps & Collars
Floors
Floors could be used to mitigate risk faced by Target Co. shareholders due to possible decline in
Buyer’s share price
◦ Negotiate a floor on the consideration

Consideration Structure with a floor

◦ If P_Buyer ≥ $80, ER – 1:1
◦ If P_Buyer < $80, ER to be adjusted so that Consideration = $80
 An Exchange offer with a Floor
$200
• Variable exchange rate for
P_Buyer < $80

$150 • If P_Buyer = 75, then ER –

80/75

• To note: Fixed ratio deal above

$100 the trigger, fixed value deal
below the trigger
• The floor makes the deal more
attractive to the target firm
$50

0 20 40 60 80 100 120 140 160 180 200

P_Buyer
An Exchange offer with a Floor
•Fixed ratio deal above the trigger, fixed value deal below the trigger
•Floating value - above the trigger, floating exchange ratio - below the trigger
•Below the trigger: There is great uncertainty about the number of shares to be
issued.
• As the buyer’s share price falls, the exchange ratio must rise in order to keep the value
constant.
• Significant dilution (of equity stake) if the price falls too low
•The floor makes the deal more attractive to the target firm
 An Exchange offer with a Floor
$200 Exchange offer with a floor is equivalent to:
Cash-plus-a-call-option
a. Cash of $80
b. An option to buy 1 share of Buyer
$150 with an exercise price of $80

$100

$50

0 20 40 60 80 100 120 140 160 180 200

P_Buyer
Caps
•Buyer may want to limit Seller’s Upside
•If the share price of Buyer is expected to go up
• Use Caps to limit Seller’s upside

•Illustration
• ER – 1:1 P_Buyer ≤ $120
• If P_Buyer > $120, ER to be adjusted so that the consideration = $120
An Exchange offer with a Cap
$200
If P_Buyer is $110, Exchange
ratio is 1:1

$150 If P_Buyer - $130, ER – 120/130

The structure ensures that

buying firm shareholders pay
$100 no more than $ 120, regardless
of what happens to P_Buyer

$50

0 20 40 60 80 100 120 140 160 180 200 P_Buyer

An Exchange offer with a Cap
•Fixed ratio deal below the trigger, fixed value deal above the trigger
•Floating value - below the trigger, floating exchange ratio - above the trigger
•Above the trigger: There is uncertainty about the number of shares to be issued.
• As the buyer’s share price rises, the exchange ratio must decrease in order to keep the
value constant.
 An Exchange offer with a Cap
$200
An exchange offer with a cap is
equivalent to: stock-minus-a-call-
option
$150 • 1 share of buyer, minus
• A call option to buy 1
share of Buyer at $120
• (Minus – target is issuing
$100 the call option to buyer)

$50

0 20 40 60 80 100 120 140 160 180 200 P_Buyer

Collars Case Study
•The combination of a floor and a cap is called a collar
•The MCI Takeover
• Deal terms offered by Verizon
• Deal terms offered by Qwest

•Competing offers by Verizon and Qwest for MCI, and the key strengths and the suitability of each
bidder.
•Pay-off for MCI shareholders as per the offer proposed by Verizon: Pay-off graph (for MCI
shareholders) and the corresponding exchange ratios when the value is fixed.
•Pay-off for MCI shareholders as per the offer proposed by Qwest: Pay-off graph (for MCI shareholders)
and the corresponding exchange ratios when the value is fixed.
Fixed Collar (Local Collar)
Value of deal is fixed and ER varies in the middle of the range
◦ Outside the range, ER is fixed, and Value of deal varies

Illustration of the Structure:

◦ ER – 1.25:1 if P_Buyer < $80
◦ ER - 0.8333, if P_Buyer > $120
◦ Otherwise, ER to be adjusted so that consideration = $100

Fixed Collar / Local

Collar Deal
$

Buyer’s Share Price

Fixed Collar (Local Collar)
Local Collar Payoff = 1.25 shares of Buyer – 1.25 call options @ 80 + .8333 Call options at $120

Fixed Collar / Local Collar

Deal
$

Buyer’s Share Price

Fixed Collar
•No doubt is left about the payment (value to be paid) as long as the buyer’s share price remains
in a reasonable range
•Stipulation that beyond that range gains and losses must be shared by both target and buyer.
•Outside of the high and low trigger points, the collar converts the fixed value deal into a fixed
exchange ratio deal.
References
•Baldwin, C.Y. (2009). Evaluating M&A Deals: Floors, Caps, and Collars. HBS No. 9-209-138.
Boston, MA: Harvard Business School Publishing.
•Bruner, R.F. (2004). Risk Management in M&A. Applied Mergers and Acquisitions (pp. 636-667).
New Jersey, USA: John Wiley & Sons, Inc
•Baker, M. P. and Quinn, J. (2012). The MCI Takeover Battle: Verizon versus Qwest. HBS No.
9206045. Boston, MA: Harvard Business School Publishing