Unit-5

Introduction
Mergers and Acquisitions (M&A) are important in the business world because
they help companies grow and change. When one company merges with or
buys another, they combine their strengths, resources, and markets, which
can lead to new opportunities and greater efficiency.

Companies go for M&A for several reasons. They might want to expand into
new markets, get new technologies, become more efficient, or offer more
products and services. Each M&A deal is a unique blend of strategy, financial
planning, and negotiation.

The terms "mergers" and "acquisitions" are often used interchangeably, but
they actually mean different things. An acquisition happens when one
company buys another completely. A merger is when two companies combine
to form a new entity under one corporate name.

To determine a company's value, you can compare it to similar companies in

the same industry and use specific financial metrics.

Whether a deal is called a merger or an acquisition can depend on how it is

perceived and communicated. If the deal is friendly and agreed upon by both
companies, it’s often seen as a merger. If one company is buying another
without the target company's full agreement, it’s considered an acquisition.
The key difference lies in how the deal is presented to the target company's
board, employees, and shareholders.

Mergers

A merger happens when two companies of about the same size come together
to form one new company, instead of staying separate. This is called a merger
of equals. A purchase deal can also be called a merger if both CEOs agree that
combining their companies is the best move for both of them.

Examples:
● Vodafone India and Idea Cellular merged to form Vodafone Idea Limited
● PVR and INOX Leisure to form PVR INOX ltd
● Citicorp and Travelers Group (1998): Citicorp, a major banking group,
and Travelers Group, a financial services company, merged to form
Citigroup.

Types of Mergers/ Structure of Mergers-

Advantages and Drawbacks of Mergers

Advantages
Reduces the cost of operations
Increases market share
Negates duplication
products/services
Mergers can save a company from
going bankrupt and also save many
jobs.
Eliminates competition
Expands consumer-base
Drawbacks
Expenses associated with logistics of
deal
The companies that have agreed to
merge may have different cultures
which may result in a gap in
communication and affect the
performance of the employees.
of May create monopoly of newly
formed company over
goods/services

Amalgamation
Like a merger, an amalgamation is a corporate strategy where one company
absorbs one or more companies, and the combined company continues to
exist. The absorbed companies move their assets, liabilities, and operations to
the new combined company. This strategy is often used to achieve vertical
integration, gain new technology or expertise, or consolidate operations.
Acquisitions
Unfriendly or hostile takeover deals, where the target companies do not want
to be bought, are always considered acquisitions.

In a simple acquisition, the acquiring company buys most of the shares of the
acquired firm, but the acquired firm keeps its name and organizational
structure.

This gives the acquiring company the power to make decisions concerning the
acquired assets without needing the approval of shareholders from the target
company.

Benefits of Acquisitions:

● Reduced Entry Barriers: Acquisitions allow companies to swiftly enter

new markets and product lines with an established brand, reputation,
and customer base, overcoming costly market entry hurdles like
research and client acquisition.
● Increased Market Power: Acquisitions can rapidly expand a company's
market share, providing a competitive advantage and achieving market
synergies despite competitive challenges.
● New Competencies and Resources
● Access to Expertise: Joining with larger entities grants access to
specialized expertise such as financial, legal, or human resources,
enhancing operational effectiveness.
● Improved Access to Capital: Post-acquisition, access to capital improves
significantly, reducing reliance on personal investments for business
expansion and enabling larger fund acquisitions.
● Fresh Perspectives to business strategies
Disadvantages of Acquisitions:
● Mismatched Acquisitions: When a company fails to seek professional
advice during the acquisition process, they risk targeting a business that
presents more obstacles than advantages. This can hinder the growth
potential of an otherwise productive organization.
● Supplier Strain: Post-acquisition, the capacity of the acquired company's
suppliers may be inadequate to meet the increased demand for services,
supplies, or materials. This can lead to production issues and
disruptions.
● Brand Impact: Mergers and acquisitions can have a detrimental effect
on the reputation of the new entity, potentially damaging the existing
brand image.

Exchange Ratio
In mergers and acquisitions (M&A), the exchange ratio determines how many
shares of the acquiring company are issued for each share of the target firm.

Exchange Ratio = Offer Price for the Target’s Shares / Acquirer’s Share Price

● The exchange ratio is crucial for understanding how mergers and

acquisitions work.
● Essentially, if the acquiring company offers 2 of its shares for every 1
share of the target company, the exchange ratio is 2:1 (meaning 2 shares
for 1).
● It's significant because both the acquiring and target companies use it to
assess their financial positions.
● E.g. A buyer wants to acquire 1,000 shares of the target company at
Rs.10 each (deal value = Rs.10,000). They plan to finance this deal 100%
with equity and are willing to issue 2,000 of their own shares valued at
Rs. 5 to pay for Rs.10,000. The transaction’s exchange ratio will be 2 : 1
i.e. (2,000/1,000).
Synergy:
Mergers and acquisitions (M&A) aim to enhance a company's financial
performance for its shareholders.

● Synergy refers to the idea that when two companies combine, their total
value and performance can exceed the sum of their individual parts.
This concept is key in synergy mergers, where companies merge to
achieve greater efficiency or scale.

● Synergy can arise from various factors such as increased revenues,

combining talent and technology, and reducing costs. Companies may
also seek synergy by integrating products or entering new markets, as
well as through cross-functional teams.

● Negative synergy, known as dis-synergy, occurs when the combined

value of merged entities is less than the value of each operating
independently. This can happen due to differences in leadership styles
and corporate cultures.

● Synergy is recorded on a company's balance sheet through goodwill, an

intangible asset representing the portion of business value not
attributed to other assets. Examples of goodwill include brand
recognition, intellectual property, and strong customer relationships.

Benefits:
● Synergies often lead to cost savings and efficiency improvements. By
eliminating duplicate functions, such as administrative overhead or
redundant facilities, companies can reduce expenses and improve
profitability.

● M&A can create opportunities for increased revenue through expanded

market reach, access to new customer segments, or complementary
product offerings. This can result in accelerated growth and enhanced
market competitiveness.
 ● Combining resources, technologies, and expertise can streamline
operations and improve productivity.

● Strategic Advantages: Enable companies to strengthen their market

position and strategic capabilities. By pooling resources and
capabilities, firms can innovate more effectively, respond to market
changes faster, and capitalize on new growth opportunities.

● Enhanced Talent Pool: M&A can bring together diverse talents and skill
sets, fostering a more capable and innovative workforce. This can lead
to improved employee morale, retention of key talent, and a stronger
organizational culture.

● Risk Mitigation: Diversification through M&A can reduce dependence on

specific markets, products, or technologies.

Types of Synergies –
Hard synergies refer to costs savings, while soft synergies refer to revenue
increases and financial synergies.

1. Cost Synergies
● Supply Chain Efficiencies
● Improved Sales and Marketing:

2. Revenue Synergies
● Patents
● Complementary products:
● Complementary geographies and customers:

3. Financial Synergies
● Diversification and Cost of Equity:
● Increased Debt Capacity:
● Tax Benefits
Post Merger EPS
Post merger earnings per share (EPS) calculates EPS as if a merger and
acquisition (M&A) has already happened, adjusting all financial metrics and
the number of shares outstanding to reflect the transaction.

Basic EPS is calculated by dividing a company’s net income by its total shares.
Earnings per share (EPS) is a ratio that investors use to gauge a company's
profitability and value. It examines the company's net earnings and divides
that by the number of outstanding shares of common stock. A higher EPS
suggests that the stock is more valuable, while a lower EPS suggests the
opposite.

Pro forma EPS, on the other hand, includes the target company's net income
and any extra benefits from the merger in the numerator, while counting the
new shares issued due to the acquisition in the denominator.

Post-merger EPS:
= Total earnings of the Acquirer after the merger / Total number of shares of
Acquirer after the merger

Post-merger price of share

The post-merger price of a share is the price at which a company's shares are
traded in the stock market after a merger or acquisition is completed. It shows
the market value of one share of the newly combined company.

1. Market Determination: The post-merger share price is decided by the

forces of supply and demand in the market. It reflects what investors
collectively think about the merged company's value and its future prospects.
Factors like financial performance, growth potential, market conditions,
industry trends, and investor sentiment influence this price.

2. Comparison with Pre-Merger Prices: Before a merger or acquisition, each

company typically has its own share price. The post-merger share price
results from combining these prices. It can differ from the pre-merger prices
due to factors such as how the merger is valued, expected benefits from
combining, market expectations, and how investors react to the deal.

3. Market Reaction: When a merger or acquisition is announced and

completed, it can significantly affect the share price. A positive market
reaction may increase the post-merger share price, showing investor
confidence in the merger's benefits and value. Conversely, concerns or
negative reactions can decrease the share price.

4. Impact on Existing Shares: The post-merger share price can also be

affected by whether existing shares are diluted or enhanced. Dilution happens
if new shares are issued during the merger, potentially reducing the value of
current shares. Enhancement occurs when the merger adds value, leading to a
higher share price.

5. Volatility and Adjustment: After a merger or acquisition, the post-merger

share price might be volatile as the market adjusts to the deal's impact. It can
fluctuate as investors react to integration uncertainties, the realization of
expected benefits, and overall market sentiment toward the combined
company.

6. Evaluation and Monitoring: Investors and analysts closely watch the post-
merger share price to assess the merger's financial impact, value creation, and
investor sentiment. It's analyzed alongside other financial data and strategic
factors to gauge the merger's success.

The post-merger share price is influenced by market dynamics and can

change over time with new information and investor reactions. Investors
should conduct thorough research and analysis, considering both financial
metrics and broader strategic implications, before making investment
decisions based on post-merger share prices.
Required Rate of Return of Merged Company
The required rate of return (RRR) is the lowest return that an investor demands in
exchange for owning a company's stock, reflecting the risk associated with
holding that stock. In corporate finance, the RRR is crucial for evaluating the
profitability of potential investment projects and is a method of measuring
payback.

● It signifies the necessary compensation for the level of risk involved.

Projects with higher risk typically have higher RRRs compared to less risky
projects.
● Involves forecasting of the cash flow of initial investment and calculating
rate of return
 ● In mergers and acquisitions, the return is readily available on investment
and typically takes lesser time to bear fruit than other financial
investments.
● When a company looks at a project, they often compare the rate of return
to their internal cost of raising money, their WACC (Weighted Average Cost
of Capital). If the project such as an acquisition returns more than the
WACC, it is considered a good deal, since they can make more money with
the project than it costs to get the money. A typical WACC for a large,
mature company in a low risk area can be 7 or 8 percent.

De-merger
A demerger involves restructuring a corporation by dividing it into separate parts,
which can operate independently, be sold off, or liquidated. This allows a large
company to split into various business units.

Reasons for a demerger typically include:

● Adapting to Economic Changes: Companies may demerge to restructure

their corporate position in response to evolving political and economic
conditions.
● Optimizing Resource Use: Demergers help companies utilize resources
more effectively, especially when the parent company struggles to do so.
● Exiting Unprofitable Ventures: If a company ventures into a business
without expertise or profitability, demerging allows them to disengage
from these areas.
● Generating Financial Resources: Companies lacking funds for acquisitions
may demerge to raise capital.
● Realizing Capital Gains: Demergers enable companies to unlock value from
underperforming assets.
● Enhancing Profit