MERGERS, ACQUISITIONS, AND

RESTRUCTURING
 WHAT IS CORPORATE RESTRUCTURING
Corporate restructuring refers to a broad array of activities
that expand or contract a firm’s operations or substantially
modify its financial structure or bring about a significant
change in its organisational structure and internal functioning.

Inter alia, it includes activities such as mergers, purchases of

business units, takeovers, demergers, leveraged buyouts,
organisational restructuring.
We will refer to these activities collectively as mergers,
acquisitions, and restructuring (a widely used, though not a
very accurate, term) or just corporate restructuring.
CORPORATE RESTRUCTURING ACTIVITIES
Acquisitions
 Mergers
 Purchase of a unit or
plant
 Takeovers
 Business alliances

Divestitures
 Sell offs
 Demergers
 Equity carve outs
Corporate
Restructuring

Ownership
Restructuring
 Going private
 Leveraged
buyouts

Organisational
Restructuring
 Organisational redesign
 Major performance
enhancement
programmes
 TYPES OF MERGER

Absorption Consolidation
A+B=A A+B=C

Horizontal Vertical Conglomerate

 Types of mergers
A horizontal merger represents a merger of firms
engaged in the same line of business.
A vertical merger represents a merger of firms
engaged at different stages of production in an
industry
A conglomerate merger represents a merger of
firms engaged in unrelated lines of business.
 REASONS FOR MERGERS
Plausible Reasons
• Strategic benefit
• Economies of scale
• Economies of vertical integration

• Complementary resources
• Tax shields
• Utilisation of surplus funds
• Managerial effectiveness
Dubious Reasons
• Diversification
• Lower financing costs
• Earnings growth
 Strategic Benefit
If a firm wants to expand its business,
acquisition of a firm engaged in that industry
may offer strategic advantages.
As a pre-emptive move it can prevent a
competitor from establishing a similar position
in that industry
It enables a firm to ‘leap frog’ several stages in
the process of expansion
It may involve less risk and even less cost.
 Economies of Scale
When two or more firms combine, certain
economies are realised due to the larger volume
of operations of the combined entity.
Economies arise due to intensive utilisation of
production capacities, distribution network, R&D
facilities.
It is more prominent in the case of horizontal
mergers due to greater utilisation of resources.
 Economies of vertical integration
When companies that are engaged at different
stages of production merge, economies of
value integration may be realised.
Eg: Merger of a company engaged in oil
exploration and production ( ONGC ) with a
company engaged in refining and marketing
( HPCL) may improve co-ordination and
control.
Vertical integration is not always a good idea
since outsourcing benefits will be lost
 Complementary resources
 If two firms have complementary
resources, it may make sense for them to
merge.
 Utilisation of surplus funds
A cash rich company intends to absorb
another company involving cash
compensation, thus representing a more
efficient utilisation of surplus funds
 Tax Shields
 When a firm with accumulated losses and
unabsorbed depreciation merges with a
profit making firm, losses and depreciation
can be set off against the profits of profit
making firm and tax benefits can be quickly
realised.
 TAX ASPECTS OF AMALGAMATIONS

An amalgamation involves the merger of one or more

companies into an existing company or the merger of
two or more companies into a new company formed
specifically for this purpose.

The merging companies are called amalgamating companies

and the merged company is called amalgamated company.
 TAX ASPECTS OF AMALGAMATIONS

The amalgamated company is entitled to various tax

benefits, if the following conditions are fulfilled :
(a) all the properties and liabilities of the amalgamating
company immediately before the amalgamation become
the properties and liabilities of the amalgamated
company by virtue of the amalgamation,
(b) shareholders holding not less than 90 percent in value
of the shares in the amalgamating company become
shareholders of the amalgamated company by the
virtue of the amalgamation.
 TAX ASPECTS OF AMALGAMATIONS
Tax concessions are granted to the amalgamated company only if
the amalgamating company is an Indian company. Following
deductions to the extent available to the amalgamating company
and remaining unabsorbed or unfulfilled will be available to the
amalgamated company:
• Capital expenditure on scientific research
• Expenditure on acquisition of patent right or copy right,

know how
• Expenditure for obtaining license to operate
telecommunication services
• Amortisation of preliminary expenses
• Carry forward of losses and unabsorbed depreciation 
 LEGAL PROCEDURE FOR
AMALGAMATION
• Examination of object clauses
• Intimation to stock exchanges
• Approval of the draft amalgamation proposal by the respective
boards
• Application to the National Company Law Tribunal (NCLT)
• Despatch of notice to shareholders and creditors
• Holding of meetings of shareholders and creditors
• Petition to the High court for confirmation and passing of High
court orders
• Filing the order with the Registrar of Companies
• Transfer of assets and liabilities
• Issue of shares and debentures
 ACCOUNTING FOR AMALGAMATIONS

According to the Accounting Standard 14 (AS-14) on

Accounting for Amalgamations issued by ICAI, an

amalgamation can be in the nature of either uniting of

interests which is referred to as ‘amalgamation in the

nature of merger’ or ‘acquisition’

CONDITIONS FOR AMALGAMATION
IN THE NATURE OF MERGER

• All assets and liabilities of the transferor  transferee

• Shareholders  90%.. equity of the transferor company

become shareholders of the transferee company.
• Consideration is paid in shares

• The business of the transferor company is intended to be

carried on by the transferee company

AN AMALGAMATION .. NOT IN THE NATURE OF

MERGER … IS TREATED AS AN ACQUISITION.
 ACCOUNTING FOR A MERGER

For a merger, the ‘pooling of interest’ method, is used.

Under the ‘pooling of interest’ method, the assets and
liabilities of the merging companies are aggregated.
Likewise the reserves appearing in the balance sheet of the
transferor company carried forward into the balance sheet
of the transferee company. The difference in capital on
account of the share swap ratio (exchange ratio) is
adjusted in the reserves.
 ACCOUNTING FOR AN ACQUISITION
For an acquisition the ‘purchase’ method is used. Under the
‘purchase’ method, the assets and outside liabilities of the transferor
company are carried into the books of the transferee company at
their fair market values.

The difference between the purchase consideration and the net book
value of assets over liabilities is treated as ‘goodwill’ that has to be
amortised over a period not exceeding five years.

Should the purchase consideration be less than the net book value of
assets over liabilities, the difference is shown as ‘capital reserve’.

Since there is often an asset write-up as well as some goodwill, the

reported profit under the purchase method is lower because of
higher depreciation charge as well as amortisation of goodwill.
 ILLUSTRATION
Beta Company (the transferor company) has agreed to merge with
Alpha Company (the transferee company). The balance sheets of
Alpha Company and Beta Company, prior to the merger, are shown.
The share swap ratio of 3:5 has been fixed. This means 3 shares of
Alpha Company will be given for 5 shares of Beta Company. Since
the par value per share is 10 for both the companies, the share
capital of Alpha will increase by Rs. 600 after the merger.

Under the ‘pooling of interest’ method, the post-merger

balance sheet of Alpha Company (the amalgamated company) would
be as shown in the first column of the Table
 ILLUSTRATION
Part A : Before Merger Part B: After Merger
Liabilities Alpha Beta Pooling Purchase
Company Company Method Method
Share capital (10 par) 4000 1000
Capital reserve - -
Share premium 2000 500
General reserve 5000 1000
P&L account 1000 500
Loan funds 4000 2500
Current liabilities and provisions 2000 1500
18000 7000
Assets
Net fixed assets 7000 3000
Investments 3000 500
Current assets 7000 3000
Miscellaneous expenditure 1000 500
18000 7000
 ILLUSTRATION
Part A : Before Merger Part B: After Merger
Liabilities Alpha Beta Pooling
Company Company Method
Share capital (10 par) 4000 1000 4600
Capital reserve - - 400
Share premium 2000 500 2500
General reserve 5000 1000 6000
P&L account 1000 500 1500
Loan funds 4000 2500 6500
Current liabilities and provisions 2000 1500 3500
18000 7000 25000
Assets
Net fixed assets 7000 3000 10000
Investments 3000 500 3500
Current assets 7000 3000 10000
Miscellaneous expenditure 1000 500 1500
18000 7000 25000
 ILLUSTRATION
Under the ‘purchase method’ the assets and outside liabilities of the transferor company
(Beta Company) are revalued. Suppose the assets and liabilities of Beta Company are
revalued as follows :
Net fixed assets : 3200
Investments : 400
Current assets : 2900
Current liabilities : 1600
Loan funds : 2400
Given these values and a purchase consideration in the form of a paid up capital of 600,
the capital reserve (or goodwill) on merger is worked out as follows :
Value of assets of Beta Company : 6500
(Fixed assets + Investments + Current assets)
Less : Value of outside liabilities : 4000
(Loan funds + Current liabilities and provisions)
Net book value of assets over liabilities 2500
Less : Purchase consideration paid to shareholders of Beta 600
Net gain on amalgamation (capital reserve) 1900
 ILLUSTRATION
Part A : Before Merger Part B: After Merger
Liabilities Alpha Beta Purchase
Company Company Method
Share capital (10 par) 4000 1000 4600
Capital reserve - - 1900
Share premium 2000 500 2000
General reserve 5000 1000 5000
P&L account 1000 500 1000
Loan funds 4000 2500 6400
Current liabilities and provisions 2000 1500 3600
18000 7000 24500
Assets
Net fixed assets 7000 3000 10200
Investments 3000 500 3400
Current assets 7000 3000 9900
Miscellaneous expenditure 1000 500 1000
18000 7000 24500
 COSTS AND BENEFITS OF A MERGER

Benefit = PVAB – (PVA + PVB)

Cost = Cash – PVB

NPV to A = Benefit – Cost

= [(PVAB – (PVA + PVB)] – [Cash – PVB]

= PVAB – PVA – Cash

NPV to B = Cost of merger from the point of view of Firm A

 ILLUSTRATION
Firm A has a value of Rs.20 million and firm B has a value of Rs.5
million. If the two firms merge, cost savings with a present value
of Rs.5 million would occur. Firm A proposes to offer Rs.6 million
cash compensation to acquire firm B. Calculate the net present
value of the merger to the two firms.
In this example PVA = Rs.20 million, PVB = Rs.5 million,
PVAB = Rs.30 million, Cash = Rs.6 million. Therefore,

Benefit = PVAB - (PVA + PVB) = Rs.5 million

Cost = Cash - PVB = Rs.1 million

NPV to A = Benefit - Cost = Rs.4 million

NPV to B = Cash - PVB = Rs.1 million
 COMPENSATION IN STOCK

Benefit = PVAB – (PVA + PVB)

Apparent cost = Mkt. value of stock compensation - PVB

True Cost =  PVAB – PVB

NPV to A = Benefit – Cost

 ILLUSTRATION

Firm A plans to acquire firm B. The relevant financial details of the

two firms, prior to the merger announcement, are:
A B
Market price per share Rs.50 Rs.20
Number of shares 1,000,000 500,000
Market value of the firm Rs.50 million Rs.10 million

The merger is expected to bring gains which have a present

value of Rs.10 million. Firm A offers 250,000 shares in exchange for
500,000 shares to the shareholders of firm B.
 ILLUSTRATION

ABC Ltd plans to acquire XYZ Ltd. The relevant financial

details of the two firms, prior to the merger announcement,
are:
ABC Ltd XYZ Ltd
Market price per share Rs.70 Rs.32
Number of shares 20 Mn 15 Mn

The merger is expected to bring gains which have a present value

of Rs.200 million. Swap ratio is 1:2

Find Apparent cost and true cost of merger

 STOCK VS. CASH
FIXED
SHARES

STOCK

FIXED
VALUE
CASH
QUESTIONS
ARE THE ACQUIRING COMPANY’S SHARES UNDERVALUED, FAIRLY VALUED,
OR OVER VALUED ?
WHAT IS THE RISK THAT THE EXPECTED SYNERGIES NEEDED TO PAY FOR
THE ACQUIS’N PREMIUM WILL NOT MATERIALISE ?
HOW LIKELY … THE VALUE OF THE ACQUIRING CO’s SHARES WILL DROP
BEFORE CLOSING ?
 COMMONLY USED BASES FOR
DETERMINING THE EXCHANGE RATIO
• Earnings per share
• Prima facie reflects earning power
• Fails to consider differences in growth, risk, and quality of earnings
• Market price per share
• In an efficient market, prices reflect earnings, growth, and risk
• The market may be illiquid or manipulated
• Book value per share
• Proponents argue that book values are objective
• Book values reflect subjective judgments and often deviate
significantly from economic values.
• DCF value per share
• Ideally suited when fairly credible business plans and cash flow
projections are available
• It overlooks options embedded in the business
 TERMS OF MERGER
• If firm 1 acquires firm 2, shares of firm 1 are given in exchange for shares of
firm 2.
• Firm 1 would try to keep the exchange ratio as low as possible, whereas firm
2 would seek to keep it as high as possible
• Larson and Gonedes developed a model for exchange rate determination.
Their model holds that each firm will ensure that its equivalent price per
share will at least be maintained as a sequel to the merger
• In somewhat simpler terms, the following symbols may be used to explain
their model.
ER = exchange ratio
P = price per share
EPS = earnings per share
PE = price-earnings multiple
E = earnings
S = number of outstanding equity shares
• In the discussion that follows, the acquiring, acquired, and combined firms
will be referred to by subscripts 1, 2, and 12 respectively.
 TERMS OF MERGER
Firm 1 would insist that the wealth of its
shareholders is preserved ie.the price per share
of the combined firm is atleast equal to the
price per share of Firm1 prior to the merger
P12 = P1
(PE12)(EPS12) = P1
(PE12)(E1+E2) = P1

S1+S2(ER1)
 TERMS OF MERGER
•The maximum exchange ratio acceptable to the
shareholders of firm 1 is:

- S1 (E1 + E2) PE12

ER1= +
S2 P 1 S2
 TERMS OF MERGERS

•Minimum Exchange Ratio required by the shareholders of

Acquired Firm ( Firm 2) in order to preserve their wealth is
P12(ER2) = P2
(PE12)(EPS12) (ER2) = P2
The minimum exchange ratio acceptable to the shareholders
of firm 2 is:

P 2 S1
ER2 =
PE12 (E1 + E2) – P2S2
 ILLUSTRATION
Firm 1 Firm 2
Total earnings, E Rs.18 mln Rs.6 mln
Number of outstanding shares, S 9 mln 6 mln
Earnings per share, EPS Rs.2 Re.1
Price/earnings ratio, PE 12 8
Market price per share, P Rs.24 Rs.8
Plugging the data from Exhibit 34.4 in Equation (34.10), we get:
-9 (18 + 6)
ER1 = + PE12
6               24(6)
= -1.5 + 1/6 PE12 (34.11)

The maximum change ratio acceptable to the shareholders of firm 1 for some illustrative
values of PE12 is shown below :

PE12 3 9 10 11 12 15 20

Max ER1 1 0 0.17 .33 0.50 1.0 1.83

 ILLUSTRATION
Plugging the data given in Exhibit 34.4 in Eq. (34.15) we get :
(8) 9
ER2 =
24 PE12 - 8 (6)
72
=
24 PE12 - 48
3
= (34.16)
PE12 - 2
The minimum exchange ratio acceptable to the shareholders of firm 2 for
some illustrative values of PE12 is given below:

PE12 3 9 10 11 12 15 20

Min ER2 3 0.43 0.38 0.33 0.30 0.23 0.17

 ILLUSTRATION
Influence of PE12 on Merger Gain and Losses

ER
Maximum exchange
ratio acceptable to
ER1 shareholders of firm 1
II

III
X
I

IV Minimum exchange
ER2
ratio required by
shareholders of firm 2
PE12
 ILLUSTRATION
Alpha company plans to acquire Beta company.
Particulars Alpha Co. Beta Co.
Total current earnings Rs.50 Mn Rs.20 Mn
No. of outstanding shares 20 Mn 10 Mn
Market price per share Rs.30 Rs.20
Price/earnings ratio, PE 12 10
a) What is the maximum exchange ratio acceptable to the
shareholders of Alpha company if the PE ratio of the
combined entity is 12 and there is no synergy gain ?
b) What is the minimum exchange ratio acceptable to the
shareholders of Beta company if the PE ratio of the combined
entity is 11 and there is a synergy benefit of 5% ?
c) Assuming that there is no synergy gain, at what level of PE
multiple will the lines ER1 and ER2 intersect?
 ILLUSTRATION
Vijay Ltd and Ajay Ltd are discussing a merger deal
in which Vijay will acquire Ajay.
Particulars Vijay Ltd. Ajay Ltd.
Total current earnings Rs.36 Mn Rs.12 Mn
No. of outstanding shares 12 Mn 8 Mn
Market price per share Rs.30 Rs.9
Price/earnings ratio, PE 10 6
Earnings per share Rs. 3 Rs.1.5
 ILLUSTRATION
Vijay Ltd and Ajay Ltd are discussing a merger deal
in which Vijay will acquire Ajay.

a) What is the maximum exchange ratio acceptable to the

shareholders of Vijay Ltd if the PE ratio of the combined
entity is 8?
b) What is the minimum exchange ratio acceptable to the
shareholders of Ajay Ltd if the PE ratio of the combined
entity is 9?
c) At what level of PE multiple will the lines ER1 and ER2
intersect?
PURCHASE OF A DIVISION/PLANT

With the step-up in corporate restructuring activity,

purchase and sale of divisions or plants are becoming

commonplace.
 PURCHASE OF A DIVISION/PLANT

The counterpart of purchase is divestiture.

If firm A purchases a plant or factory or business

division of firm B, from the point of firm B it
represents a divestiture.

Purchases (and divestitures) are expected to grow

in importance in the years to come as firms
restructure themselves with greater freedom in the
more liberalised industrial environment.
PROCEDURE FOR VALUING
A PURCHASE

Discounted Cash flow Method

Step 1: Define the present value of the free cash flow from

the purchase.

Step 2: Establish the horizon value and discount it to the

present time.

Step 3: Add the present value of free cash flow and horizon

value to get the value of purchase.

PROCEDURE FOR VALUING
A PURCHASE

Global Ltd is interested in acquiring the foods division of

Regional company. The forecast of free cash flow for the
proposed purchase, as developed by Global Ltd is shown in the
following exhibit. It is based on the following assumptions.

a) the growth rate in assets, revenues and profit after tax will be
20% for the first three years, 12% for the next two years and 8%
thereafter.

b) the ratio of NOPAT to net assets would be 0.12

c) the opportunity cost of capital for the purchase is 11%.

 ILLUSTRATION
Free Cash Flow
Rs. in million
Year 1 2 3 4 5 6 7 8
Asset value 50.00 60.00 72.00 86.40 96.77 108.38 117.05 126.41
NOPAT 6.00 7.20 8.64 10.37 11.61 13.00 14.05 15.17
Net investment 10.00 12.00 14.40 10.37 11.61 8.67 9.36 10.11
FCF (4.00) (4.80) (5.76) - - 4.33 4.69 5.06
Growth rate(%) 20 20 20 12 12 8 8 8

-4.00 -4.80 -5.76 0 0 4.33

PV (FCF) = – – + + +
(1.11) (1.11)2 (1.11)3 (1.11)4 (1.11)5 (1.11)6

= - Rs.9.40 million Contd.,

The horizon value at the end of six years, applying the constant
growth model, is:
FCFH + 1 4.69
VH = = = Rs.156.33 million
r-g 0.11-0.08
The present value of VH is:

156.33
= Rs.83.64 million
(1.11)6
Adding the present value of free cash flow and the present
value of horizon value, gives the value of acquisition:
V0 = -9.40 + 83.64 = Rs.74.24 million
 KEY TERMS
NOPLAT : Net op.profit after adj. the taxes .. cash basis
EBIT – Tax on EBIT
INVESTED CAPITAL : Amount invested in the operat’s of the firm
Net Work.cap + Net P, P, & E + Net other assets
(CA – NIBCL)
TOTAL AMOUNT INVESTED : Invested Capital + Non-op.investments
FREE CASH FLOW : NOPLAT – Net investt
NON-OPER’G CASH FLOW : After-tax cash flow from items not related to
operations
FCFF TOTAL FUNDS AVAILABLE : FCF+NOCF = FINANCING CASH FLOW
TO INVESTORS
ROIC : NOPLAT / INV.CAP
ECONOMIC PROFIT : INV.CAP [ROIC – WACC]
COMPANY VALUE : DISCOUNTED VALUE OF FORECASTED FCF &
CV+ VALUE OF ANY NON-OP ASSETS WHOSE
CFS WERE EXCL. train FCT
 DEFINE THE FCFF
NOPLAT

OPERATING FREE CASH

FLOW (OFCF) FCF NET INV
FCFF
NON OPERATING CASH
FLOW (NOCF)
NOPLAT stands for net operating profit less adjusted taxes. It is equal to :
EBIT – Taxes on EBIT
EBIT is pre-tax operating income the firm would have earned if it had no debt :
PBT + Interest expense – Interest income – Non – operating income
Taxes on EBIT represent the taxes the firm would pay if it had no debt, excess
marketable securities, non-operating investments, or extraordinary income or
loss.
Net Investment is the difference between gross investment and depreciation
Non-operating Cash Flow Non-operating cash flow arises from extraordinary
items like profit from sale of assets, restructuring expenses, & so on.
 FINANCIAL STATEMENTS OF MATRIX LIMITED
FOR THE PRECEDING THREE YEARS (YEARS 1 – 3)
Rs.in million
Profit and Loss Account
1 2 3
Net Sales 180 200 229
Income from marketable securities - - 3
Non-operating income - - 8
Total income 180 200 240
Cost of goods sold 100 120 125
Selling and general administration expenses 30 35 45
Depreciation 12 15 18
Interest expenses 12 15 16
Total costs and expenses 154 170 204
PBT 26 30 36
Tax provision 8 9 12
PAT 11 12 12
Retained earnings 7 9 12
 BALANCE SHEET

1 2 3
Equity capital 60 90 90
Reserves & surplus 40 49 61
Debt 100 119 129
Total 200 258
280
Fixed assets 150 175 190
Investment - 20 20
Net current assets 50 63 70
Total 200 258
28
 FINANCING FLOW
The FCFF equals the total funds available to investors, which is referred to
as the financing flow
Financing flow = After tax interest expense
+ Cash dividend on equity and preference capital
+ Redemption of debt
- New borrowings
+ Share buybacks
- Share issues
+ Excess marketable securities
- After tax income on excess marketable securities
Note : Excess marketable securities (MS) are regarded as negative debt. So
a change in excess MS is treated as a financing flow. For the same reason,
the post-tax income on excess MS is regarded as a financing flow
 MATRIX LIMITED
EBIT OF MATRIX TAX ON EBIT
PBT 36 TAX PROV 12
+ INT.EXP +16 + TAX SHIELD ON INT .. EXP + 6.4
- INT .. INC -3 - TAX ON INT INCOME - 1.2
- NON-OP.INC -8 - TAX ON NON-OP INCOME - 3.2
41 M 14.0 M
NOPLAT = 41 – 14 = 27 M
NET INV = (190 + 70) – (175 + 63) = 22 M
NOCF = NOI (1 - . 4) = 8 x 0.6 = 4.8 M
FCFF = 27 – 22 + 4. 8 = 9.8
FINANCING FLOW
AFTER-TAX INT.EXPENSE 9.6
+ CASH DIV ON PREF & EQUITY 12.0
+ REDEM’N OF DEBT -
- NET BORROWINGS 10.0
+ SHARE BUYBACKS -
- SHARE ISSUES -
+ EXCESS MS -
- AFTER-TAX INCOME ON EXCESS MS 1.8
9.8
 PERSPECTIVE ON THE DRIVERS OF FCF
FCF = NOPLAT - NET INVESTMENT
NET INVESTMENT
= NOPLAT 1-
NOPLAT

NOPLAT NET INVEST’T

= INVESTED CAPITAL 1-
INVESTED CAPITAL NOPLAT

NOPLAT TURNOVER NET INV / INV. CAP

= INVESTED CAPITAL 1 -
TURNOVER INVESTED NOPLAT / INV. CAP
CAPITAL

POST-TAX CAPITAL GROWTH RATE

= INVESTED CAPITAL OPERATING TURNOVER 1-
MARGIN ROIC
FREE CASH FLOW DRIVERS FOR MATRIX LIMITED
FOR YEARS 2 AND 3
Year 2 Year 3
Invested capital (Beginning of the year) Rs.200 mln Rs.238 mln
Invested capital (End of the year) Rs.238 mln Rs.260 mln
NOPLAT Rs. 30 mln Rs. 27 mln
Turnover Rs.200 mln Rs.229 mln
Net investment Rs. 38 mln Rs. 22 mln
Post-tax operating margin 15.00% 11.79%
Capital turnover 1.00 0.962
NOPLAT
ROIC = 15.00% 11.34%
Invested capital
Growth rate 19.00% 9.24%
Free cash flow Rs. 8 mln Rs. 5 mln
 Projected Profit and Loss Account and Balance Sheet for Matrix Limited
Five Years – Years 4 through 8 – The Explicit Forecast Period
Rs. in million
Profit and Loss Account

4 5 6 7 8
 Net sales 270 320 360 400 440
 Income from excess marketable securities 3 2 - - -
 Non-operating income - - - - -
 Total income 273 322 360 400 440
 Cost of goods sold 144 173 193 218 245
 Selling and general administration 47 59 67 70 77
 Depreciation 22 26 29 32 35
 Interest expense 18 20 21 23 25
 Total costs and expenses 231 278 310 343 382
 Profit before tax 42 44 50 57 58
 Tax provision 13 16 18 19 18
 Profit after tax 29 28 32 38 40
 Dividend 15 15 15 16 16
 Retained earnings 14 13 17 22 24
Balance Sheet
 Equity capital 90 90 90 90 90
 Reserves & surplus 75 88 105 127 151
 Debt 140 150 161 177 192
Total 305 328 356 394 433
 Fixed assets 220 240 266 294 324
 Investments 10 - - - -
 Net current assets 75 88 90 100 109
Total 305 328 356 394 433
 Free Cash Flow Forecast for Matrix Limited for Five Years – Years 4 through
8 – The Explicit Forecast Period
4 5 6 7 8
1. Profit before tax 42 44 50 57 58
2. Interest expense 18 20 21 23 25
3. Interest income 3 2 - - -
4. Non-operating income - - - - -
A. EBIT (1) + (2) - (3) - (4) 57 62 71 80 83
5. Tax provision in income statement 13 16 18 19 18
6. Tax shield on interest expense 7.2 8.0 8.4 9.2
10.0
7. Tax on interest income (1.2) (0.8) - - -
8. Tax on non-operating income - - - - -

B. TAXES ON EBIT : (5)+(6)-(7)-(8) 19.0 23.2 26.4 28.2 28.0

C : NOPLAT : (A) – (B) 38.0 38.8 44.6 51.8 55.0
D : NET INVESTMENT 35.0 33.0 28.0 38.0 39.0
E : FREE CASH FLOW : (C) – (D) 3.0 5.8 16.6 13.8 16.0

CONTINUING VALUE
As discussed earlier, a company’s value is the sum of two terms :
Present value of cash flow during + Present value of cash flow after
the explicit forecast period the explicit forecast period
3 5.8 16.6 13.8 16.0 FCF9 17.6
+ + + + = = 440
(1.14) (1.14) 2
(1.14) 3
(1.14)4
(1.14) 5
COC - GR .14 - .10
440
= 34.78 PV (CV) = = 228.36
(1.14) 5

VALUE OF . . NON-OP ASSETS = 20

FIRM VALUE = 34.78 + 228.36 + 20 = 283.14
 TAKEOVERS

• A takeover generally involves the acquisition of a certain

block of equity capital of a company which enables the
acquirer to exercise control over the affairs of the
company

• A takeover may be done through the following ways

• Open market purchase
• Negotiated acquisition
• Preferential allotment
 PROS AND CONS OF TAKEOVERS
• Takeovers often generate a lot of controversy. As DePamphilis puts it:

“The corporate takeover has been dramatised in Hollywood as motivated by

excessive greed, reviled in the press as a destroyer of jobs and of local
communities, sanctified on Wall Street as a means of dislodging
incompetent
management, and often heralded by shareholders as a source of windfall
gains. The reality is that corporate takeovers may be a little of all of these
things.” 1
• Proponents of takeover argue that takeovers improve the quality of
management, facilitate forward and backward linkages with the other
operations of the acquirer, and afford scope for realising synergistic
benefits.
• T.Boone Pickens, Jr., a very eloquent of takeovers regards them as a device
for punishing weak managements and protecting the interests of small
shareholders.

1
Donald Depamphilis, Mergers, Acquisitions, and Other Restructuring
Activities, Academic Press, San Diego: 2001.
 PROS AND CONS OF TAKEOVERS
• Warren Law argues that managers do much more for their companies
and shareholders than the raiders (or predators) who are primarily
interested in making a ‘fast buck’ and seeing their pictures on magazine
covers. Peter Drucker, too, is opposed to takeovers.
• Scientific research, however, supports takeovers. Michael Jensen and
Richard S. Ruback2, who have summarised the scientific evidence, say:
“In brief, the evidence seems to indicate that corporate takeovers
generate positive gains, that target firm shareholders benefit, and that
bidding firm shareholders do not lose. Moreover, the gains created by
corporate takeovers do not appear to come from the creation of market
power. Finally, it is difficult to find managerial actions related to
corporate control that harm shareholders.”

Michael C. Jensen and Richard S. Ruback, "The Market for Corporate

2

Control - The Scientific Evidence", Journal of Financial Economics, vol

11, No. 1, pp. 5-50
 REGULATION OF TAKEOVERS

Takeovers may be regarded as a legitimate device in the

market for corporate control provided they are regulated
by the following principles:

• Transparency of the process

• Protection of the interest of small shareholders

• Realisation of economic gains

• No undue concentration of market power

 SEBI TAKEOVER CODE

The key provisions of the SEBI Takeover code relate to the

following

• Disclosure

• Trigger point

• Offer price

• Contents of the public announcement

• Creeping acquisition
ANTI-TAKEOVER DEFENSES
IN THE U.S
Pre-offer Defenses
• Staggered board
• Super majority clause
• Poison pills
• Dual class recapitalisation
• Golden parachute
Post-offer Defenses
• Greenmail
• Pacman defence
• Litigation
• Asset restructuring
• Liability restructuring
 TAKEOVER DEFENSES

• MAKE PREFERENTIAL ALLOTMENTS

• EFFECT CREEPING ENHANCEMENTS
• SEARCH FOR A WHITE KNIGHT
Oberoi Hotels takeover by ITC
Reliance Industries – White Knight\
EIH : 34.3%, ITC:14.98%, RIL:14.80%
• SELL THE CROWN JEWELS
• AMALGAMATE GROUP COMPANIES
• RESORT TO BUYBACK OF SHARES
 BUSINESS ALLIANCES
Business alliances such as joint ventures, strategic alliances, equity
partnerships, licensing, franchising alliances, and network alliances have
grown significantly. In many situations, well-designed business alliances
are viable alternatives to mergers and acquisitions. No wonder they have
become commonplace in diverse fields like high-technology, media and
entertainment, automobiles, pharmaceuticals, oil exploration, and financial
services. Here are some conspicuous examples:
• General Motors and Toyota entered into an unprecedented joint
venture agreement in the 1980s.
• Merck has over 100 R&D alliances with a variety of entities.
• In 1999, IBM announced business alliances worth $ 30 billion with
companies like Cisco and Dell computers.
• Oracle has over 15,000 alliances with its business partners
 COMMON FORMS OF BUSINESS ALLIANCES

• Joint ventures

• Strategic alliances

• Equity partnership

• Licensing

• Franchising alliance

• Network alliance
 RATIONALE FOR BUSINESS ALLIANCES

• Sharing risks and resources

• Access to new markets

• Cost reduction

• Favourable regulatory treatment

• Prelude to acquisition or exit

 WHAT MAKES A BUSINESS
ALLIANCE SUCCEED
The following factors are critical to the success of a business
alliance:
• The partners have complementary strengths.
• The cost of developing a new product is exorbitant for a single
firm.
• The partners have the ability to cooperate with one another.
• There is clarity of purpose, roles, and responsibilities.
• The apportionment of risks and rewards are perceived as
equitable by all parties.
• The partners have similar time horizons and financial
expectations.
 STRATEGIC AND OPERATIONAL PLANS
Before addressing deal-structuring issues, the prospective partners
must:
• Analyse the alliance’s strengths, weaknesses, opportunities,
and threats relative to the competition
• Spell out the roles and responsibilities of each partner in
running the day to day operations of the business alliance
• Develop an implementation schedule with completion dates
and the names of individuals responsible for each major
activity
• Prepare financial forecasts and budgets
• Set up a performance-tracking system to compare actual
performance with budgeted performance
 DEAL STRUCTURING
Before an alliance agreement is signed, a series of deal-structuring
issues have to be resolved. The key issues relate, in the main, to the
following:
• Scope and duration
• Legal form
• Resource contributions and ownership determination
• Management and control
• Performance measurement and monitoring
• Dispute resolution mechanism
• Revision of the agreement
• Termination of the agreement
• Transfer of interest
• Handling of confidential information
• Allocation of tax burden and savings
• Regulatory compliances
 FIVE SINS OF ACQUISITIONS

• Straying too for a field

• Striving for bigness

• Leaping before looking

• Overpaying

• Failing to integrate well

 MANAGING THE ACQUISITION PROGRAMME
1) MANAGE THE PREACQUISITION PHASE
LEVERAGE
 VAL’N OWN CO. BRAINSTORMING
ECO .. SCALE

2) SCREEN CANDIDATES
 TOO LARGE  TOO SMALL  UNRELATED  HIGH P/E EXPORT
 AMENABLE PROMOTERS

3) EVALUATE THE REMAINING CANDIDATES

 ALL FACETS  PREMIUMS 20-60%  SYNERGY TRAP

4) DETERMINE THE MODE OF ACQUISITION

MERGER - PURCHASE - TAKEOVER
ABO - LEASING - MGT. CONTACT
5) NEGOTIATE & CONSUMMATE THE DEAL
L.N.MITTAL’S .. STEEL PLANT . . MEXICO SIBALSA . . $2.2 b . . 220m 25 + 195 PROMISSORY
NOTE . . 10YRS

6) MANAGE THE POST-ACQUISITION INTEGRATION

 ANTICIPATE & SOLVE PROBLEMS EARLY
 TREAT PEOPLE WITH DIGNITY & CONCERN
 MODES OF ACQUISITION : HOW
DOTHEYCOMPARE
TAKEOVER PURCHASE MERGER
 OBJECT SHARES UNIT COMPANY
 PROCESS OPEN OFFER CLEARANCES APPROVALS
/ MARKET
 TAXATION (SHs) ATTRACTED NA NIL
 TAXATION (CO.) NA ATTRACTED NA
 STAMP DUTY 1/2% .. 0% APPLICABLE NIL
(HIGH)
 PRICING MARKET DRIVEN VALUATION VALUATION
 EXTENT OF 26 - 51% 100% OF THE 100% OF THE
ACQUISITION UNIT COMPANY
 CONSIDER’N CASH / SHARES CASH SHARES
 TO WHOM MEMBERS COMPANY MEMBERS
 DIVESTITURES

Mergers, asset purchases, and takeovers lead to expansion

in some way or the other. They are based on the principle
of synergy which says 2 + 2 = 5! Divestitures, on the other
hand, involve some kind of contraction. It is based on the
principle of “anergy” which says 5 – 3 = 3!

Among the various methods of divestiture, the more

important ones are partial sell-off, demerger (spinoff and
split-up), and equity carveout. Note that some scholars
define divestitures rather narrowly as partial selloff. We
define divestitures more broadly to include partial selloffs,
demergers, and so on.
 PARTIAL SELL-OFF
A partial selloff, also called slump sale, involves the sale of a business
unit or plant of one firm to another. It is the mirror image of a
purchase of a business unit or plant. From the seller’s perspective, it
is a form of contraction; from the buyer’s point of view it is a form
of expansion. For example, when Coromandal Fertilisers Limited
sold its cement division to India Cement Limited, the size of
Coromandal Fertilisers contracted whereas the size of India
Cements Limited expanded.
Motives for Sell off
• Raising capital
• Curtailment of losses
• Strategic realignment
• Efficiency gain
FINANCIAL EVALUATION
OF A SELL-OFF

1. Estimate the divisional post-tax cash flow

2. Establish the discount rate for the division
3. Calculate the division’s present value
4. Find the market value of division-specific liabilities
5. Deduce the value of the parent’s ownership position in
the division
6. Compare the value of ownership position (VOP) with
the divestiture proceeds (DP) and decide.
 MANAGING DIVESTMENTS

1. Regard divestments as a normal part of business life.

2. Consider divestment as one of the many responses to

a situation

3. Approach divestments positively

 DEMERGERS

A demerger results in the transfer by a company of

one or more of its undertakings to another
company.
The company whose undertaking is transferred is
called the demerged company and the company (or
the companies) to which the undertaking is
transferred is referred to as the resulting company.
 DEMERGERS
A demerger may take the form of a spinoff or a split-up. In a
spinoff an undertaking or division of a company is spun off into an
independent company.
After the spinoff, the parent company and the spun off company are
separate corporate entities.
In a split-up, a company is split up into two or more independent
companies. As a sequel, the parent company disappears as a
corporate entity and in its place two or more separate companies
emerge.
Rationale for Demergers
• Sharper focus
• Improved incentives and accountability
VALUE SPLITS
COMPANY ASSETS SPUN OFF
Reliance Energy Power projects 
Bharti Airtel,Vodafone Towers 
Reliance Communications Towers 
Hinduja TMT IT and ITeS business 
Indiabulls Financial Services Real estate undertaking 
Sun Pharma Innovative R&D division 
Camlin Chemicals division 
GTL Infrastructure unit 
GE Shipping Offshore services business 
Zee Regional channels and cable 
GMR Industries Ferro alloys 
Silverline Technologies Animation business 
Media Video Real estate division 
Electronic manufacturing 
Solectron Centum Electronics
services business
 EQUITY CARVEOUT

In an equity carve out, a parent company sells a portion of

its equity in a wholly owned subsidiary. The sale may be to
the general investing public or to a strategic investor.

Eg: TCS carve out from Tata Sons Ltd through an IPO in
August 2004
 EQUITY CARVEOUT

An equity carve out differs from a spin off in the

following ways:
(a) In a spinoff the shares of the spun off company are
distributed to the existing shareholders of the parent
company, whereas in an equity carve out the shares are sold
to new investors.
(b) An equity carve out brings cash infusion to the parent
company, whereas a spin off does not.
Equity carve outs are undertaken to bring cash to the
parent and to induct a strategic investor in a subsidiary.
 LEVERAGED BUYOUT
A leveraged buyout involves transfer of ownership
consummated mainly with debt.
While some leveraged buyouts involve a company in its
entirety, most involve a business unit of a company.
Often the business unit is bought out by its management
and such a transaction is called management buyout
(MBO).
After the buyout, the company (or the business unit)
invariably becomes a private company.
 LEVERAGED BUYOUT
What Does Debt Do?

A leveraged buyout entails considerable dependence on

debt.
What does it imply? Debt has a bracing effect on
management, whereas equity tends to have a soporific
influence.
Debt spurs management to perform whereas equity lulls
management to relax and take things easy.
 LEVERAGED BUYOUT
Risks and Rewards
The sponsors of a leveraged buyout are lured by the
prospect of wholly (or largely) owning a company or a
division thereof, with the help of substantial debt finance.
They assume considerable risks in the hope of reaping
handsome rewards.
The success of the entire operation depends on their ability
to improve the performance of the unit, contain its
business risks, exercise cost controls, and liquidate
disposable assets.
If they fail to do so, the high fixed financial costs can
jeopardise the venture.
 HOLDING COMPANY
A holding company owns the stock of other companies to exercise
control over them
Advantages
• Control with fractional ownership
• Isolation of risk
• Enormous financial leverage
Disadvantages
• Partial multiple taxation
• Parental responsibility
• Magnified risk
 ORGANISATIONAL RESTRUCTURING

 REGROUPING OF BUSINESSES LARSEN & TOUBRO

 DECENTRALISATION HINDUSTAN LEVER
 DOWNSIZING TISCO
 OUTSOURCING TELCO
 BUSINESS PROCESS FORD MOTOR CO.
RE-ENGINEERING
 ENTERPRISE RESOURCE MAHINDRA & MAHINDRA
PLANNING
 TOTAL QUALITY WIPRO
MANAGEMENT
 PROFESSIONALISATION OF RANBAXY
MANAGEMENT WIPRO
 DYNAMICS OF RESTRUCTURING
1. EVEN THOUGH … ENVIRONMENTAL CHANGE . .
GRADUAL PROCESS . . CR EPISODIC & CONVULSIVE
2. CONDITIONS … CONDUCIVE TO RESTRUCTURING
 EVIDENCE . . S&S … ERODED BENEFITS …
ONE/MORE KEY CORPORATE CONSTITUENCIES
 SHIFT . . BALANCE OF POWER . . FAVOUR . . DISADV..
PARTY
 OPTIONS
 LEADERSHIP
3. CORPORATE RESTR’G … PERIODICALLY . . CONTINUING
. . TENSION BETWEEN … ORG’NAL NEED . . STABILITY &
CONTINUITY . . ONE HAND … ECO COMPULSION . .
ADAPT TO CHANGES . . OTHER
 SUMMING UP
• Mergers, takeovers, divestitures, spinoffs, and so on, referred to
collectively as corporate restructuring have become a major force
in the financial and economic environment all over the world
• Corporate restructuring can occur in myriad ways. Business firms
resort to a variety of activities that lead to expansion, selloffs, and
changes in ownership and control.
• Mergers represent a very important form of corporate
restructuring. Mergers, as used in financial literature, subsume
both absorption and consolidation.
• A takeover generally involves the acquisition of a certain block of
equity capital of a company which enables the acquirer to exercise
control over the affairs of the company.
• While there is considerable controversy about takeovers in the
popular literature, scientific evidence seems to indicate that
corporate takeovers generate positive gains, that target firm's
shareholders benefit, and that the bidding firm's shareholders do
not lose.
• Mergers, asset purchases, and takeovers lead to expansion in some
way or the other. They are based on the principle of synergy
which says 2 + 2 = 5! Portfolio restructuring, on the other hand,
involves some kind of contraction through a divestiture or a
demerger. It is based on the principle of "anergy" which says

5–3=3!
• A divestiture involves the sale of a division or plant or unit of one
firm to another. From the seller's perspective, it is a form of
contraction; from the buyer's point of view, it represents
expansion.
• A demerger results in the transfer by a company of one or more of
its undertakings to another company. The company whose
undertaking is transferred is called the demerged company and
the company (or the companies) to which the undertaking is
transferred is referred to as the resulting company.
• A demerger may take the form of a spinoff or a split-up. In a
spinoff, an undertaking or division of a company is spun off into
an independent company. In a split-up, a company is split-up into
two or more independent companies.
• A leveraged buyout involves concentration of equity in few hands
with the help of debt. The sponsors of a leveraged buyout are
lured by the prospect of wholly (or largely) owning a company or
a division thereof, with the help of substantial debt finance. They
assume considerable risks in the hope of reaping handsome
rewards.
• A holding company owns the stocks of other companies to exercise
control over them. The advantages of a holding company are:
control with fractional ownership, isolation of risk, and enormous
leverage. The disadvantages of a holding company are: partial
multiple taxation and magnified risk.
• Privatisation involves transfer of ownership (generally represented
by equity shares), partial or total, of public enterprises from the
government to individuals and non-governmental institutions. The
privatisation programmes of various countries have been
motivated by a desire to improve efficiency, generate resources,
and promote popular capitalism.
• Many firms have begun organisational restructuring exercises in
recent years to cope with heightened competition. The common
elements of most organisational restructuring and performance
enhancement programmes are : regrouping of business,
decentralisation, downsizing, outsourcing, business process
engineering, enterprise resource planning, and total quality
management.
• Corporate restructuring is often an episodic exercise. Corporate
restructuring occurs periodically due to an ongoing tension
between the organisational need for stability and continuity on the
one hand and the economic compulsion to adapt to changes on the
other.