Mergers & Acquisition

Introduction
 Business Combinations
METHODS OF BUSINESS
COMBINATION
There are several methods for
achieving a business combination. It
is useful to have an understanding of
these different methods.
Business Combinations(Contd)
Acquisition
An acquisition can take the form of a purchase of the stock
or other equity interests of the target entity, or the
acquisition of all or a substantial amount of its assets.
* Share purchases - in a share purchase the buyer buys
the shares of the target company from the shareholders of
the target company. The buyer will take on the company
with all its assets and liabilities.
* Asset purchases - in an asset purchase the buyer buys
the assets of the target company from the target company.
In simplest form this leaves the target company as an
empty shell, and the cash it receives from the acquisition is
then paid back to its shareholders by dividend or through
liquidation. However, one of the advantages of an asset
purchase for the buyer is that it can "cherry-pick" the
assets that it wants and leave the assets - and liabilities -
that it does not.
Business Combinations(Contd)
Merger
In a merger, two separate companies
combine and only one of them survives. In
other words, the merged (acquired)
company goes out of existence, leaving its
assets and liabilities to the acquiring
company. Usually when two companies of
significantly different sizes merge, the
smaller company will merge into the
larger one, leaving the larger company
intact.
Business Combinations(Contd)
Consolidation
A consolidation is a combination of two or more
companies in which an entirely new corporation is
formed and all merging companies cease to exist.
Shares of the new company are exchanged for
shares of the merging ones. Two similarly sized
companies usually consolidate rather than merge.
Although the distinction between merger and
consolidation is important, the terms are often
used interchangeably, with either used to refer
generally to a joining of the assets and liabilities
of two companies.
 M & A - Definitions
Various authors give variety of
definitions for mergers and
acquisitions.
A merger in the true legal sense
happens when two or more
businesses dissolve and fold their
assets and liabilities into a newly
created third entity.
 M & A - Definitions
“The buying, selling and combining of
different companies to grow rapidly
without having to create another business
entity”
M & As are the most popular means of
corporate restructuring or business
combinations.
Corporate restructuring includes mergers
and acquisitions (M & As), amalgamation,
takeovers, spin-offs, leveraged buy-outs,
buyback of shares, capital reorganisation
etc.
 Different definitions

A takeover refers to the transfer of control of the firm from one group
“
of shareholders (i.e. the “bidder”) to another
Takeovers occur by acquisition, proxy contest, or going private
Proxy contests occur when a group of shareholders attempts to gain
controlling seats on the board of directors by voting in new directors.
In going private transactions all the share of a public firm are
purchased by a small group of investors. The shares are delisted from
stock exchanges.
 Basic forms of M & A
Merger
– Absorption of one firm by another, and
it acquires all of the assets and liabilities
of the acquired firm
– Acquired firm ceases to exist
Acquisition
– Of stock: buying stock in a public offer
– Of assets: buying all the assets in an
offer
Business Combinations(Contd)
Leveraged Buyout
A leveraged buyout (LBO) is a type of acquisition
that occurs when a group of investors,
sometimes led by the management of a company
(management buyout or MBO), borrows funds to
purchase the company. The assets and future
earnings of the company are used to secure the
financing required to purchase the company.
Sometimes employees are allowed to participate
through an employee stock ownership plan,
which may provide tax advantages and improve
employee productivity by giving employees an
equity stake in the company.
Business Combinations(Contd)
Holding Company
A holding company is a company that owns
sufficient voting stock to have a controlling
interest in one or more companies called
subsidiaries. Effective working control or
substantial influence can be gained through
ownership of as little as 5 percent to as much as
51 percent of the outstanding shares, depending
on how widely the shares are distributed. A
holding company that engages in the
management of the subsidiaries is called a parent
company.
Business Combinations(Contd)
Divestitures
While divestitures do not represent a business
combination, they are a means of facilitating the
acquisition of part of a company. Sometimes
divestitures are used by companies as a means to
improve earnings and shareholder value, or as a
means of raising capital. A divestiture involves the
sale of a portion of a company. Two popular means
of divestiture are spin-offs and equity carve-outs.
In a spin-off, a company distributes all of its shares
in a subsidiary to the company's shareholders as a
tax-free exchange.
An equity carve-out is similar to a spin-off. It
occurs when a company sells some of its shares
in a subsidiary to the public.
MOTIVES FOR ACQUISITIONS
The overriding motive for any acquisition should
be to maximize shareholder value.
Economies of scale: This refers to the fact that
the combined company can often reduce
duplicate departments or operations, lowering
the costs of the company relative to theoretically
the same revenue stream, thus increasing profit.
* Increased revenue/Increased Market Share:
This motive assumes that the company will be
absorbing a major competitor and increase its
power (by capturing increased market share) to
set prices.
MOTIVES FOR ACQUISITIONS
* Cross selling: For e.g., a bank buying a stock broker
could then sell its banking products to the stock
broker's customers, while the broker can sign up the
bank's customers for brokerage accounts. Or, a
manufacturer can acquire and sell complementary
products.
* Synergy: Better use of complementary resources.
* Taxes: A profitable company can buy a loss maker to
use the target's tax write-offs. In the United States and
many other countries, rules are in place to limit the ability
of profitable companies to "shop" for loss making
companies, limiting the tax motive of an acquiring
company.
Geographical or other diversification: This is designed to
smooth the earnings results of a company, which over the
long term smoothens the stock price of a company, giving
conservative investors more confidence in investing in the
company. However, this does not always deliver value to
shareholders
MOTIVES FOR ACQUISITIONS
Resource transfer: resources are unevenly
distributed across firms and the
interaction of target and acquiring firm
resources can create value through either
overcoming information asymmetry or by
combining scarce resources.
* Financial restructuring: a change in
control can lead to a more cost-effective
or safer capital structure, and more
efficient use of financial assets.
* Business mix restructuring: the
acquirer may divest non-core businesses
 Benefits of Mergers and
Acquisitions
The most common advantages of
M&A are:
– Accelerated Growth
– Enhanced Profitability
Economies of scale
Operating economies
Synergy
– Diversification of Risk
 Benefits of Mergers and
Acquisitions
– Reduction in Tax Liability
– Financial Benefits
Financing constraint
Surplus cash
Debt capacity
Financing cost
– Increased Market Power
 Analysis of Mergers and
Acquisitions
There are three important steps
involved in the analysis of mergers
or acquisitions:
– Planning
– Search and screening
– Financial evaluation
 WHY GROW THROUGH
ACQUISITIONS?

There are numerous reasons for a company to

want to grow. Growth is often considered vital to
the health of a company. A stagnating company
may have difficulty attracting high-quality
management. Furthermore, larger companies
may pay higher salaries to top management than
smaller companies. In some industries, size itself
may bring competitive advantages. For example,
marketing dominance may be strengthened
through improved access to advertising.
 WHY GROW THROUGH
ACQUISITIONS?
In addition, a large company may have
significantly higher production or distribution
efficiencies than a smaller one. Sometimes
growth is a means of survival. For example,
companies in the telecommunications industry
have grown through acquisition in an effort to
compete to control phone lines, cable systems,
and content. Firms in the defense industry have
merged to survive in a declining market. Finally,
tax laws may encourage merger growth.
 Companies at Risk?

Chronic underperformers
Perception of “missed opportunities’
Lower market capitalization relative
to peers
Substantial cash balances
 Leveraged Buy-outs
A leveraged buy-out (LBO) is an acquisition of
a company in which the acquisition is
substantially financed through debt. When the
managers buy their company from its owners
employing debt, the leveraged buy-out is called
management buy-out (MBO).
The following firms are generally the targets for
LBOs:
– High growth, high market share firms
– High profit potential firms
– High liquidity and high debt capacity firms
– Low operating risk firms
The evaluation of LBO transactions involves the
same analysis as for mergers and acquisitions.
The DCF approach is used to value an LBO.
Tender Offer and Hostile Takeover
A tender offer is a formal offer to
purchase a given number of a company’s
shares at a specific price.
Tender offer can be used in two situations.
– First, the acquiring company may directly approach
the target company for its takeover. If the target
company does not agree, then the acquiring
company may directly approach the shareholders
by means of a tender offer.
– Second, the tender offer may be used without any
negotiations, and it may be tantamount to a
hostile takeover.
 Regulation of Mergers and
Takeovers in India
In India, mergers and acquisitions are
regulated through:
– The provision of the Companies Act, 1956,
– The Monopolies and Restrictive Trade Practice
(MRTP) Act, 1969,
– The Foreign Exchange Management Act, 1999,
– The Income Tax Act, 1961, and
– The Securities and Controls (Regulations) Act,
1956.
The Securities and Exchange Board of India (SEBI) has issued
guidelines to regulate mergers, acquisitions and takeovers.
 Regulation of Mergers and
Takeovers in India
Legal Measures against Takeovers
Refusal to Register the Transfer of Shares:
– a legal requirement relating to the transfer of shares have not
be complied with; or
– the transfer is in contravention of the law; or
– the transfer is prohibited by a court order; or
– the transfer is not in the interests of the company and the
public.
Protection of Minority Shareholders’
Interests
SEBI Guidelines for Takeovers:
– Disclosure of share acquisition/holding
– Public announcement and open offer
Offer price
Disclosure
Offer document
 Legal Procedures
Permission for merger
Information to the stock exchange
Approval of board of directors
Application in the High Court
Shareholders’ and creditors’ meetings
Transfer of assets and liabilities
Payment by cash or securities
 Accounting for Mergers and
Acquisitions
Pooling of Interests Method
In the pooling of interests
method of accounting, the balance
sheet items and the profit and loss
items of the merged firms are
combined without recording the
effects of merger. This implies that
asset, liabilities and other items of
the acquiring and the acquired firms
are simply added at the book values
without making any adjustments.
 Accounting for Mergers and
Acquisitions
Purchase Method
Under the purchase method, the
assets and liabilities of the acquiring
firm after the acquisition of the
target firm may be stated at their
exiting carrying amounts or at the
amounts adjusted for the purchase
price paid to the target company.
 Types of strategic fit
Geographic Roll –up M&A
Product or Market extension
Kraft –US$12.9 billion
R&D
Industry convergence M&A