Professional Documents
Culture Documents
Module 2 CR
Module 2 CR
11
How Companies Can Work
Together
Joint venture: parties work together for lengthy or
indeterminate period of time
Form new, third entity
Divide ownership and control of new entity, determine who will
contribute what resources
Advantage: two entities can remain focused on their core
businesses while letting joint venture pursue the new
opportunity
Downside: governance issues and economic fairness issues
create friction and eventual disbandment
Restructuring - Expansion
o Joint ventures
o Two companies enter into an agreement to provide certain
resources for a specific business purpose and a limited duration.
o e.g. Hindustan Motors & Mitsubishi to produce Lancer & Pajero
o JV between Maruti Udyog and Suzuki of Japan – Now Maruti Suzuki
India Ltd
o Sony Corporation (Japan) And Erricsson (Sweden) (Split the JV
after 10 years Oct 2011)
How Companies Can Work Together
Strategic alliance (or teaming agreement): parties
work together on a single project for a finite period
of time
Do not exchange equity
Do not create permanent entity to mark relationship
Written memorandum of understanding (MOU):
memorializes strategic alliance and sets forth how
parties plan to work together
E.g. M Pesa – ICICI bank and Vodafone India
Uber and Paytm; Uber & Spotify;
Google and Luxottica
Restructuring - Contraction
o Reduction in size of the firm
o Divestiture
o Selling assets, divisions, subsidiaries to another
corporation or combination of corporations or
individuals, generally resulting in an infusion of
cash.
o Types
o Spin - offs
o Split - ups
o Equity carve - outs
o Assets sale
Restructuring – Contraction
Spin-offs
A new, independent company created by detaching
either a division of a parent company’s assets and
operations or a subsidiary.
Shares in the new company are distributed to the
parent company’s shareholders on a pro rata basis.
e.g. IT division of Wipro was spun off as Wipro
Infotech in 1980s;
Godrej’s Retail division ‘Nature’s basket’ (Feb, 2009)
Pantaloon Retail spin off Big Bazaar and Food
bazaar into a new entity Future value retail (March,
2009)
L&T spun off its cement business (2002)
Restructuring - Contraction
o Split-ups
o The entire company is broken up into two or more
companies, parent company no longer exists
o With one or more spin-offs
o New class of stock for each company
o e.g. Cendant (US) – 4 cos real estate; travel; hospitality,
vehicle rental business in 2005 ;
o APSEB into APGENCO & APTRANSCO (1999)
Restructuring - Contraction
o Equity carve-out
o Offering of full or partial interest in a subsidiary to the
investment public OR IPO of a corporate subsidiary OR to a
strategic partner
o e.g DuPont in 1998 subsidiary Conoco; Lucent (1996);
AT&T (1993)
o Asset sale
o Sale of tangible or intangible assets of a company to generate
cash
o Cash to shareholders and go out of existence/continue to do
business
o e.g. Asset sale of Dabhol Power company (2005) (now
called RGPPL - Ratnagiri Gas and Power Private Limited)
Corporate Control
Anti take over defenses
Share buyback/repurchases
Debt equity Exchange offers
Financial reorganisation (bankruptcy)
Proxy contests
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Restructuring – Corporate Control
o Obtaining control over the management of a firm;
o To influence in organisational strategies
o Share Buybacks/repurchases
o Company buying its own shares back from the existing
shareholders or from open market.
o Reduction in equity capital
o Strengthens promoter’s controlling position
o Takeover defense
o Treasury Stock
o e.g.DLF (2008); ipca (2008); Reliance infrastructure, Infosys,
TCS
o Takeover defenses
o To prevent a sudden, unexpected hostile takeover and
gaining control of the company
Restructuring – Corporate Control
– Exchange offers
– On or more classes of securities the right or option to exchange a
part or all their holding for a different class of securities of the firm
– Exchanging debt for equity (increases leverage) or Equity for debt
(decreases leverage)
– Financial Reorganisation and bankruptcy
• Restructuring when firm experiences financial distress
– Out of court procedures
– Merger into another firm
– Formal legal proceedings – reorganisation OR liquidation
– Proxy contests
• Attempt by a single or a group of shareholders to
– Take control in a company; Expel the board or management
Source : ICFAI material, p.9. begi.
Weston, Mitchell & Muherin. (2006). Takeovers, restructuring, and corporate governance, 4th ed., New Delhi : Pearson Education,
pp.370-82.
Changes in ownership structures
• Leveraged buyout
• Junk bonds
• Going private
• ESOPs
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Restructuring – Changes in ownership structure
– Leveraged Buyout (LBO)
• A leveraged buyout (LBO) is the acquisition of a company or division of
a company (“target”) financed with a substantial portion of borrowed
funds. Debt : 80 to 90% (assets as collaterals)
» Debt is used for acquiring a company
» Often applied to firm borrowing fund to buy back its own stock
MBOs; EBO – Tata Tea (Kannan Devan ) 2005
o Going Private
o Transformation of a public limited company into a
privately held firm
o Delisting
o companies’ desire to avoid scrutiny of
shareholders, regulators and potential investors,
and also avoid payment of exorbitant compliance
costs associated therewith.
o e.g. Essar steel; Carrier Aircon India Ltd, Otis
Elevator Company India Ltd
Restructuring – Changes in ownership structure
ESOP
o An ESOP is a kind of employee benefit plan. In an ESOP, a
company sets up a trust fund, into which it contributes new
shares of its own stock or cash to buy existing shares
o Mechanism whereby a company can make tax deductible
contributions of cash or stock into a trust.
o An ESOP is nothing but an option to buy the company's share
at a certain price. This could either be at the market price
(price of the share currently listed on the stock exchange), or at
a preferential price (price lower than the current market price).
o If the firm has not yet gone public (shares are not listed on any
stock exchange), it could be at whatever price the
management fixes it at.
o Not taxed until withdrawn; Anti take over defence
Types of mergers
Horizontal
Vertical
Conglomerate
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MERGERS AND ACQUISITIONS DEFINITIONS
Classified by the relatedness of business activities of the parties to the combination:
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Types of Mergers/Strategies
oHorizontal mergers
oMerger between two firms competing in
the same industry
oIncreases firm’s market power.
oe.g. SBI and State Bank of Indore (2010);
Nedungadi Bank and Punjab national Bank
(2003)
Facebook and WhatsApp
Board of Editors. (2003). Mergers and acquisitions. Vol 1, New Delhi : ICFAI University Press, pp.91-95
Ross, Westerfield & Jordan (2006). Fundamentals of Corporate Finance, 7th ed. New York:McGraw -Hill Irwin,
28
p.798.
Horizontal merger
• Cement industry – Birla with L&T
• Liquor industry United Breweries with Shaw Wallace
• Diageo with United Spirits
• Aviation industry – Jet Airlines with Air Sahara.
• Vodafone acquisition on HEL, telecommunication industry
(2007)
• Vodafone and Idea
Examples of Horizontal Merger
• Lipton India and Brooke Bond.
• Pixar-Disney Merger
oConglomerate mergers
oMerger between firms that are not related
to each other or unrelated business
activity.
oProduct extension
ogeographic market extension
opure conglomerate mergers
• # Product-extension merger –
– Conglomerate mergers which involves companies selling
different but related products in the same market or sell non-
competing products and use same marketing channels of
production process.
– E.g. Phillip Morris-Kraft (1988), Pepsico- Pizza Hut, Proctor and
Gamble and Clorox
• # Market-extension merger –
– Conglomerate mergers wherein companies that sell the same
products in different markets/ geographic markets.
– E.g. Morrison supermarkets and Safeway, (supermarkets)
– Time Warner (telecommunications)-TCI (Cable Television
provider)
• # Pure Conglomerate merger-
– two companies which merge have no obvious relationship of
any kind. E.g. BankCorp of America- Hughes Electronics
Example of Conglomerate Merger
• merger between the Walt Disney Company and the American
Broadcasting Company.
• Tata- Sky
• L&T and Voltas
Congeneric merger
A congeneric merger involves firms that are interrelated, but
not identical, lines of business.
A congeneric merger is a merger in which one firm acquires
another firm that is in the same general industry but neither in
the same line of business nor a supplier or a customer.
Congeneric merger
bank and a leasing company.
Citigroup's acquisition of Travelers
Insurance
While both were in the financial services industry,
they had different product lines.
Prudential Financial and stock brokerage
company Bache & Co (1981)
Although both companies were involved in the
financial services sector, prior to the deal, Prudential
was focused primarily on insurance while Bache dealt
with the stock market.
Motives or Reasons for
M&As
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Motivations for M&A OR Why M&As happen
• Synergy
– Operating Synergy
– Financial Synergy
• Diversification (Related/Unrelated)
• Strategic realignment
– Technological change
– Deregulation
• Financial considerations
– Acquirer believes target is undervalued
– Booming stock market
– Falling interest rates
• Market power
• Ego/Hubris
• Tax considerations
Synergy
• Value realised from the incremental cash flows
generated by combining two businesses
– E.g. if market value of two firms is $100m and $75m
respectively and their combined value is $200m,
then value of synergy is $25m
• Two types
– Operating Synergy
• Improve operating efficiency
– Financial Synergy
• Reduction in acquirer’s cost of capital due to M&A
Operating synergy
• Examples
– P&G uses its consumer marketing skills to sell full range of personal
care as well as healthcare products (Acquired old spice (1990),
Gillette (2005),…….)
– Honda employs proprietary know-how (an intangible asset) to
enhance internal combustion engines to manufacture, in addition to
cars and motorcycles
Illustrating Economies of Scope
Post-Merger:
Pre-Merger:
• Firm A’s and Firm B’s data processing
centers are combined into a single
• Firm A’s data processing operation to support all 8 manufacturing
center supports 5 facilities
manufacturing facilities • By combining the centers, Firm A is able
• Firm B’s data processing to achieve the following annual pre-tax
center supports 3 savings:
manufacturing facilities – Direct labor costs = $840,000.
– Telecommunication expenses =
$275,000
– Leased space expenses = $675,000
– General & administrative expenses =
$230,000
Key Point: Cost savings due to expanding the scope of a single center to
support all 8 manufacturing facilities of the combined firms.
Complementary technical assets and skills
o Possessed by one firm that could be used by another
to fill the gap in its technical capabilities
Board of Editors. (2003). Mergers and acquisitions. Vol 1, New Delhi : ICFAI University Press, pp.95-125
Merger/acquisition Process
1. Developing the strategic plan for the business
Where to compete, how to compete, self assessment,
defining mission statement, setting objectives,
selecting strategy
Mission and vision of the firm
2. Merger Plan
Key management objectives – financial & non
financial; tactical plan
Resource assessment
Schedule for completion
3. The Search Process
Establish a primary screening – industry, size,..
Develop the search strategy
Merger/acquisition Process
4. The Screening Process
Starts with Initial list of potential list of potential
candidates
Criteria – Specific market or product segment,
profitability, degree of leverage and market share
5. First Contact
Alternate approach strategies
Discussing value
Income (DCF); Market (Comparables Company); Asset
and other approaches
Preliminary legal documents
Confidentiality agreement, letter of intent
Merger/acquisition Process
6. Negotiation
• Defining purchase prices
• Refining valuation
• Structuring the Deal
• Legal, tax and accounting structures
• How assets are transferred, ownership
• Conditions on which either of the parties
would withdraw
• Due diligence
– Buyer’s and seller’s due diligence
• Developing a financing plan
Due diligence
To prevent “unpleasant surprises”
Assessing costs and benefits
Past, present and predictable future
Sources of value and liability
Any litigation, contingent liability, all contratcs
Team of
Executives of the target/bidding firm
Investment bankers
Lawyers
Chartered accountants
Merger/acquisition Process
7. Developing the Integration Plan
Benefit packages, contracts for employees
8. Closing – company changes hands
Closing document consists of
– Purpose of acquisition
– Price
» Allocation of price; Payment mechanism
» Assumption of liabilities
– Covenants – obligations of both parties
– Conditions for closing
– Indemnification
– Other documents Articles of incorporation; litigations;
contracts; loan agreements; stock option schemes;
insurance policies
Merger/acquisition Process