merger and acqusitions


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Merger & Acquisition : 

Merger & Acquisition Neena Sinha

Slide 2: 

What is a merger? A merger refers to a combination of two or more companies into a single company. This combination may be either through absorption or consolidation. Merger through Absorption:- An absorption is a combination of two or more companies into an 'existing company'. All companies except one lose their identity in such a merger. For example, absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd (TCL). TCL, an acquiring company (a buyer), survived after merger while TFL, an acquired company (a seller), ceased to exist. TFL transferred its assets, liabilities and shares to TCL. Merger through Consolidation:- A consolidation is a combination of two or more companies into a 'new company'. In this form of merger, all companies are legally dissolved and a new entity is created . Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash or exchange of shares. For example, Merger of Brooke Bond India Ltd. with Lipton India Ltd resulted in the formation of a new company Brooke Bond Lipton India Ltd. .

Acquisitions and Takeovers : 

Acquisitions and Takeovers An acquisition may be defined as an act of acquiring effective control by one company over assets or management of another company without any combination of companies. Thus, in an acquisition two or more companies may remain independent, separate legal entities, but there may be a change in control of the companies. When an acquisition is 'forced' or 'unwilling', it is called a takeover. In an unwilling acquisition, the management of 'target' company would oppose a move of being taken over. But, when managements of acquiring and target companies mutually and willingly agree for the takeover, it is called acquisition or friendly takeover.

Acquisitions and Takeovers : 

Acquisitions and Takeovers Under the Companies Act (Section 372), a company's investment in the shares of another company in excess of 10 percent of the subscribed capital can result in takeovers. An acquisition or takeover does not necessarily entail full legal control. A company can also have effective control over another company by holding a minority ownership.

What is M & A : 

What is M & A Mergers and acquisition looks tempting and easier from the seashore but in reality its a deep sea whose secrets are difficult to learn and imbibe. It’s a process which is so much complicated that a small mistake and the company involved is bound to be doomed and successful vice- versa.

What drives M & A : 

What drives M & A The valuation differences of the share prices lead to Acquisitions of firms that are low-valued from the viewpoint of outsiders (M.Gort 1969). Lower interest rates also lead to more Acquisitions, as Acquiring firms rely heavily on borrowed funds (R.Melicher et al 1983).

Types of Mergers : 

Types of Mergers Horizontal merger:- is a combination of two or more firms in the same area of business. For example, combining of two book publishers or two luggage manufacturing companies to gain dominant market share. Vertical merger:- is a combination of two or more firms involved in different stages of production or distribution of the same product. For example, joining of a TV manufacturing (assembling) company and a TV marketing company or joining of a spinning company and a weaving company. Vertical merger may take the form of forward or backward merger. When a company combines with the supplier of material, it is called backward merger and when it combines with the customer, it is known as forward merger. Conglomerate merger:- is a combination of firms engaged in unrelated lines of business activity. For example, merging of different businesses like manufacturing of cement products, fertilizer products, electronic products, insurance investment and advertising agencies. L&T and Voltas Ltd are examples of such mergers.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions Accelerating a company's growth, particularly when its internal growth is constrained due to paucity of resources Enhancing profitability Diversifying the risks of the company A merger may result in financial synergy and benefits for the firm in many ways Limiting the severity of competition by increasing the company's market power.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions Accelerating a company's growth, particularly when its internal growth is constrained due to paucity of resources. Internal growth requires that a company should develop its operating facilities- manufacturing, research, marketing, etc. But, lack or inadequacy of resources and time needed for internal development may constrain a company's pace of growth. Hence, a company can acquire production facilities as well as other resources from outside through mergers and acquisitions. Specially, for entering in new products/markets, the company may lack technical skills and may require special marketing skills and a wide distribution network to access different segments of markets. The company can acquire existing company or companies with requisite infrastructure and skills and grow quickly.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions Enhancing profitability because a combination of two or more companies may result in more than average profitability due to cost reduction and efficient utilization of resources. This may happen because of:- Economies of scale:- arise when increase in the volume of production leads to a reduction in the cost of production per unit. This is because, with merger, fixed costs are distributed over a large volume of production causing the unit cost of production to decline. Economies of scale may also arise from other indivisibilities such as production facilities, management functions and management resources and systems. This is because a given function, facility or resource is utilized for a large scale of operations by the combined firm.

Advantages of Mergers & Acquisitions : 

Operating economies:- arise because, a combination of two or more firms may result in cost reduction due to operating economies. In other words, a combined firm may avoid or reduce over-lapping functions and consolidate its management functions such as manufacturing, marketing, R&D and thus reduce operating costs. For example, a combined firm may eliminate duplicate channels of distribution, or crate a centralized training center, or introduce an integrated planning and control system. Advantages of Mergers & Acquisitions

Advantages of Mergers & Acquisitions : 

Synergy:- implies a situation where the combined firm is more valuable than the sum of the individual combining firms. It refers to benefits other than those related to economies of scale. Operating economies are one form of synergy benefits. But apart from operating economies, synergy may also arise from enhanced managerial capabilities, creativity, innovativeness, R&D and market coverage capacity due to the complementarity of resources and skills and a widened horizon of opportunities. Advantages of Mergers & Acquisitions

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This concept of synergy, can be explained symbolically as follows: If company A merges with company B, the value of the merged entity, called say AB, is expected to be greater than the sum of the independent values of A and B, i.e., V (AB) > V (A) + V (B) Where V (AB) = value of the merged entity V (A) = Independent value of company A V (B) = Independent value of company B Synergy

Net Worth : 

Net Worth Definition 1 For a company, total assets minus total liabilities. Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation. Net worth can be used to determine creditworthiness because it gives a snapshot of the company's investment history. also called owner's equity, shareholders' equity, or net assets.Definition 2 For an individual, the value of a person's assets, including cash, minus all liabilities. The amount by which the individual's assets exceed their liabilities is considered the net worth of that person.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions Diversifying the risks of the company particularly when it acquires those businesses whose income streams are not correlated. Diversification implies growth through the combination of firms in unrelated businesses. It results in reduction of total risks through substantial reduction of cyclicality of operations. The combination of management and other systems strengthen the capacity of the combined firm to withstand the severity of the unforeseen economic factors which could otherwise endanger the survival of the individual companies.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions A merger may result in financial synergy and benefits for the firm in many ways:- By eliminating financial constraints By enhancing debt capacity. This is because a merger of two companies can bring stability of cash flows which in turn reduces the risk of insolvency and enhances the capacity of the new entity to service a larger amount of debt By lowering the financial costs. This is because due to financial stability, the merged firm is able to borrow at a lower rate of interest.

Slide 17: 

• Utilization of tax shields: When a firm with accumulated losses and /or unabsorbed tax shelters merges with a profit-making firm, tax shields are utilized better as its losses and /or unabsorbed tax shelters can be set off against the profits of the profit-making firm and tax benefits can be quickly realized. • Higher debt capacity: It is frequently argued that the merged entity enjoys a higher debt capacity because the earnings of the merged entities are more stable than the independent earnings of the merging entities. A higher debt capacity, the argument continues, means greater tax advantage to a higher firm value.

Advantages of Mergers & Acquisitions : 

Advantages of Mergers & Acquisitions Limiting the severity of competition by increasing the company's market power A merger can increase the market share of the merged firm. This improves the profitability of the firm due to economies of scale. The bargaining power of the firm vis-à-vis labour, suppliers and buyers is also enhanced. The merged firm can exploit technological breakthroughs against obsolescence and price wars.

Procedure for evaluating the decision for mergers and acquisitions : 

Procedure for evaluating the decision for mergers and acquisitions Planning:- of acquisition will require the analysis of industry-specific and firm-specific information. The acquiring firm should review its objective of acquisition in the context of its strengths and weaknesses and corporate goals. It will need industry data on market growth, nature of competition, ease of entry, capital and labour intensity, degree of regulation, etc. This will help in indicating the product-market strategies that are appropriate for the company. It will also help the firm in identifying the business units that should be dropped or added. On the other hand, the target firm will need information about quality of management, market share and size, capital structure, profitability, production and marketing capabilities, etc.

Procedure for evaluating the decision for mergers and acquisitions : 

Procedure for evaluating the decision for mergers and acquisitions Search and Screening:- Search focuses on how and where to look for suitable candidates for acquisition. Screening process short-lists a few candidates from many available and obtains detailed information about each of them. Financial Evaluation:- of a merger is needed to determine the earnings and cash flows, areas of risk, the maximum price payable to the target company and the best way to finance the merger. In a competitive market situation, the current market value is the correct and fair value of the share of the target firm. The target firm will not accept any offer below the current market value of its share. The target firm may, in fact, expect the offer price to be more than the current market value of its share since it may expect that merger benefits will accrue to the acquiring firm.

Due Diligence : 

Due Diligence Generally, the information that an acquirer expects is broken down into the following categories: General Corporate Matters Financial, Accounting, and Taxes Technology and Intellectual Property Product / Service Offerings Operations Sales and Marketing Human Resources and Personnel Legal and Regulatory

Due Diligence : 

Due Diligence Within each category, there tend to be two distinct types of requests: document requests and questions to be answered over the phone and in meetings. Often, it possible that there will be a “priority” due diligence checklist early in the process and a more detailed one later. Also, a savvy acquirer will want to see projections, reports, and other documents actually used by the company, as opposed to specially-created projections and reports just for the M&A process. Ultimately, anything that could be material enough to affect the valuation of the business is fair game. Since the potential acquirer doesn’t know what is material until it asks, the initial due diligence list can be overly long, with a number of requests that are irrelevant.

Key issues governing due diligence ( investigation) : 

Key issues governing due diligence ( investigation) Assessing the quality of earnings Identifying key business drivers and operating result trends Analyzing key balance sheet components and valuation issues, for example, identifying overvalued assets and undervalued liabilities Analyzing working capital sensitivity and seasonality relative to proposed target levels Quantifying tax exposures Considering areas of non-financial due diligence such as: Operations and technology due diligence HR due diligence Coordinating with other advisors/investors (e.g., legal, lenders) Supporting the buyer's negotiating position and purchase price adjustments Providing input to purchase and debt agreements and other related documents

Key Steps… : 

Key Steps… Pre-Acquisition Due Diligence Identification of hidden and potential liabilities and cash-flow implications, as well as major gaps in the target company's current insurance and employee benefits programs including pension fund valuation and transfer Integration Assistance with the identification of the skills and resources needed to ensure a smooth integration Pre-Closing Design of post-completion insurance and benefits programme before the transaction date to take advantage of enhanced coverage and competitive pricing Post-Closing Ensuring the recommendations highlighted in the due diligence reports are implemented

Due diligence consists of four distinct steps : 

Due diligence consists of four distinct steps Signing the confidentiality agreement – a launching pad for the due diligence process Establish formal ground rules Determine exceptions Re ensure confidentiality Creating and delivering the due diligence request Prioritizing Detailing Documenting Handling the information exchange Evaluating the information provided Timeliness Thoroughness Team composition Executive involvement Friendly cooperation with target Strategic foresight

Valuation methodologies… : 

Valuation methodologies… method that provides an appropriate value in every case as each target Since most M&A transactions are expected to deliver synergies, a discounted cash flow method is often used as it takes into account future benefits to the acquirer Valuation method would normally be supplemented with other valuation techniques to obtain an appropriate range of values for the target company Other No single universal valuation techniques utilized may include an analysis of comparable transactions in a similar industry to obtain earnings or revenue multiples An asset valuation focused on replacement cost or perhaps a Greenfield analysis which would assess the cost to start from scratch a business similar to the target Actual price paid for the target business is often a function of the negotiating skill of the acquirer and the perceived risks and rewards of the investment which varies significantly for each potential investor

Financial due diligence – key driver to valuation basis : 

Financial due diligence – key driver to valuation basis Key focus of financial due diligence, for the buyer and by implication the seller, is to identify issues which will have a direct impact on the valuation drivers and therefore, the valuation of the target company.  For example, should the pricing agreed with the seller is based on a discounted cash flow model, then the financial due diligence should assess the assumptions used in the target's projected cash flows and identify key risk areas and appropriate adjustments in light of historical performance.  If the pricing is to be determined using an earnings multiple, then the financial due diligence should seek to identify adjustments to the target's reported earnings to arrive at sustainable earnings against which the earnings multiple would be applied.  In both examples, financial due diligence seeks to validate the underlying valuation assumptions of the target and therefore has a direct impact on the valuation.

Post due diligence process : 

Post due diligence process

Integration checklist : 

Integration checklist

Competitive advantage : 

Competitive advantage Unmatched scale and scope High margin, low cost producer Unmatched R & D capabilities Geographic and product diversity Integrated business model Strong financial profile – uniquely positioned for growth Synergies in the management team and the knowledge management

Thank you for your attention : 

Thank you for your attention

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