introduction to principles of mergers & acquisitions
DESCRIPTION
Fundamentals of Mergers with some real life Indian casesTRANSCRIPT
Corporatisation of Non Corporate Entity, Conversion of Corporatisation of Non Corporate Entity, Conversion of Proprietary Concern & Partnership to CompanyProprietary Concern & Partnership to Company
andandCorporate restructuring Corporate restructuring
byby
CA. Nitant TrilokekarCA. Nitant Trilokekar
Why convert to CompanyWhy convert to Company
Limited liability (exp to Bankers)Limited liability (exp to Bankers) Greater borrowing powerGreater borrowing power Market profileMarket profile Internal settlementInternal settlement Employee stability new technology Employee stability new technology
organisationsorganisations Vehicle for acquisitions and mergersVehicle for acquisitions and mergers
Procedure for Conversion of Procedure for Conversion of partnership firm into companypartnership firm into company
Incorporate a company which can legally take over the business of the firm and continue the same business under Part IX of the Companies Act, 1956
The firm may be converted into a company by following the provisions of Part IX of the Companies Act, 1956 Sections 565 to 581 prescribes the law and procedureAdvantage : business can be run under the same name
Key ConditionsKey Conditions All partners of the partnership firm shall become shareholders of All partners of the partnership firm shall become shareholders of
the company in the the company in the same proportion same proportion in which their capital in which their capital accounts stood in the books of the firm on the date of the accounts stood in the books of the firm on the date of the conversion.conversion.
The partners receive consideration only by way of allotment of The partners receive consideration only by way of allotment of shares in companyshares in company
and The partners share holding in the company in aggregate is and The partners share holding in the company in aggregate is 50% or more of its total voting power 50% or more of its total voting power
and and continue to be as such for 5 yearscontinue to be as such for 5 years from the date of from the date of conversion.conversion.
Key RequirementsKey Requirements Minimum Share Capital shall be Rs. 100,000 (INR One Lac)
for conversion into a Private Limited Company Minimum Share Capital shall be Rs. 500,000 (INR five Lac)
for conversion into a Public Limited Co. If the above requirement is not fulfilled by the firm, then the
Partnership deed should be altered Minimum 7 Shareholders
Minimum 2 Directors (for Private Limited Co.) and 3 Directors (for Public Limited Co.)
The directors and shareholders can be same person DIN (Director Identification Number) for all the Directors DSC (Digital Signature Certificate) for two of the Directors
Key BenefitsKey Benefits
Automatic Transfer All the assets and liabilities of the firm immediately
before the conversion become the assets and liabilities of the company.
No Stamp Duty No instrument of transfer is required to be executed
and hence no stamp duty is required to be paid. No Capital Gain Tax Continuation of Brand Value Carry Forward and Set off Losses and Unabsorbed
Depreciation
STEPS FOR INCORPORATION OF STEPS FOR INCORPORATION OF COMPANY UNDER PART IXCOMPANY UNDER PART IX
Partner’s meetingPartner’s meeting• Ascent of majority not less than 3/4 Ascent of majority not less than 3/4 • Authorize one or more partners Authorize one or more partners • Execute a supplementary Partnership Deed toExecute a supplementary Partnership Deed to
atleast 7 partners atleast 7 partners registered with the Registrar of Firmsregistered with the Registrar of Firms fixed capital fixed capital provision of converting a firm into companyprovision of converting a firm into company agreement by the partners to convert the partnership agreement by the partners to convert the partnership
to a company.to a company.
• Execute a settlement deed.Execute a settlement deed.
Mergers & AcquistionsMergers & Acquistions
Acquisitions and RestructuringAcquisitions and Restructuring
Very popular strategy during the 20th Century.
55,000 acquisitions in the 1980s worth $1.3 trillion.
Pace of acquisitions picked up in the 1990s.
40-45 of acquisitions in recent years involved cross-border transactions.
India commenced in a large way after conversion of Rupee
Why restructure?Why restructure?
Restructure definedRestructure defined Restructuring may include company Restructuring may include company
reorganisation, closure, insolvency, merger & reorganisation, closure, insolvency, merger & acquisition, downsizing, externalisation and acquisition, downsizing, externalisation and delocalisation. delocalisation.
Restructuring is driven by several factors Restructuring is driven by several factors including a more open global economy, including a more open global economy, downturns in economic growth, an ageing downturns in economic growth, an ageing population, introduction of new technologies population, introduction of new technologies affecting ways of working and the necessity to affecting ways of working and the necessity to combat climate change and to reduce combat climate change and to reduce environmental impact. environmental impact.
When does the corporate restructure? When does the corporate restructure? When a company is having trouble making When a company is having trouble making
payments on its debt, it will payments on its debt, it will oftenoften consolidate and consolidate and adjust the terms of the debt in a debt adjust the terms of the debt in a debt restructuring.restructuring.
What does it aim to restructure? What does it aim to restructure? A company restructures its operations or structure by
cutting costs, such as payroll, or reducing its size through the sale of assets.
After a debt restructuring, the payments on debt are more manageable for the company and the likelihood of payment to bondholders increases.
Types of Types of RestructureRestructure
Antecedents (Triggers) of RestructuringAntecedents (Triggers) of Restructuring
EnvironmentEnvironment
GovernanceGovernance
RestructuringRestructuring
PerformancePerformanceFinancialFinancial
RestructuringRestructuring
StrategyStrategy
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Environmental Environmental
EnvironmentalEnvironmental- CompetitionCompetition- Takeover threatsTakeover threats- tax motivations tax motivations
Governance -- Governance -- Weak governanceWeak governance• Ineffective managementIneffective management• Complacent boardComplacent board• Inadequate incentivesInadequate incentives• Lack of ownership concentration (institutional investor Lack of ownership concentration (institutional investor activism).activism).
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Triggers for Re-structuringTriggers for Re-structuring
Strategy Strategy - Poor strategy or implementationPoor strategy or implementation- OverdiversificationOverdiversification- LeverageLeverage
Performance Performance - Poor or declining performance- Poor or declining performance- Difference between desired and actual performance- Difference between desired and actual performance- Assets are undervalued- Assets are undervalued- Perceived threat of takeover- Perceived threat of takeover
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Financial restructuringFinancial restructuring
- LBOs (divisional MBOs)LBOs (divisional MBOs)- Employee stock options plans Employee stock options plans (ESOPs)(ESOPs)- Equity financed share repurchasesEquity financed share repurchases- Targeted share repurchases Targeted share repurchases (greenmail)(greenmail)
• Leveraged recapitalizationsLeveraged recapitalizations• Leveraged cash-outsLeveraged cash-outs• Leveraged share repurchasesLeveraged share repurchases• Securities swaps (debt for equity) Securities swaps (debt for equity)
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Modes of restructuringModes of restructuring
Asset restructuringAsset restructuring
- DownsizingDownsizing
• Employee layoffsEmployee layoffs• Mixed resultsMixed results• 89% cite expense reduction (46% succeeded)89% cite expense reduction (46% succeeded)• 67% for competitive advantage (19% succeeded)67% for competitive advantage (19% succeeded)• Which employees leave or stay?Which employees leave or stay?
- Downscoping- Downscoping
• Divestitures (sell-offs, spin-offs, split-ups)Divestitures (sell-offs, spin-offs, split-ups)• Plant closingsPlant closings• LiquidationsLiquidations
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Divestitures (sell-offs versus spin-Divestitures (sell-offs versus spin-offs)offs)
Spin-off represents a pro-rata distribution of shares of a Spin-off represents a pro-rata distribution of shares of a subsidiary to shareholders.subsidiary to shareholders.
Occurs within the hierarchy.Occurs within the hierarchy. Terms and valuation of the assets are set Terms and valuation of the assets are set internally internally Parent stockholders create new board Parent stockholders create new board Parent can maintain ties with spun-off unit.Parent can maintain ties with spun-off unit.
Spin-offSpin-off
Sell-off (De merger)Sell-off (De merger)
Sell-offs: Assets are sold to another firm for cash and/or Sell-offs: Assets are sold to another firm for cash and/or securities.securities.
Occurs outside the hierarchy. Occurs outside the hierarchy. Value determined by market forces.Value determined by market forces. Acquiring firm absorbs and governs the sold-off Acquiring firm absorbs and governs the sold-off assets asassets as part of its hierarchy.part of its hierarchy.
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MERGERMERGER The aspect of corporate strategy, corporate finance and The aspect of corporate strategy, corporate finance and
management dealing with the buying, selling and management dealing with the buying, selling and combining of different companies that can aid, finance, or combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly help a growing company in a given industry grow rapidly
without having towithout having to create another business entity.create another business entity. A merger can resemble a takeover but result in a new A merger can resemble a takeover but result in a new
company name (company name (often combining the namesoften combining the names of the original of the original companies) and in new branding; in some cases, terming companies) and in new branding; in some cases, terming the combination a "merger" rather than an acquisition is the combination a "merger" rather than an acquisition is done purely for political or marketing reasons.done purely for political or marketing reasons.
Acquisitions and RestructuringAcquisitions and Restructuring Acquisition Types:
• Mergers:
Two firms join and integrate operations as co-equals. Chrysler – Diamler Benz example.
• Acquisitions:
One firm buys a controlling interest in another firm with the intent to make the other firm a division or subsidiary of the acquiring firm. In general these agreements are friendly but do not result in a co-equal relationship. Novell’s acquisition of German-based SuSE gives Novell an in-house source for Linux desktop and server operating systems.
• Hostile Takeovers: Acquisition bid is unsolicited. Generally results in incumbent management being removed. Yahoo’s takeover bid for HotJobs to thwart TMP Worldwide (a rival of Yahoo).Microsoft’s alliance with Yahoo to thwart entry of Google is NOT a merger
AcquisitionsAcquisitions
Rationales for Making AcquisitionsRationales for Making Acquisitions
IncreaseIncreasemarket powermarket power
OvercomeOvercomeentry barriersentry barriers
Cost of newCost of newproduct developmentproduct development
Increase speedIncrease speedto marketto market
IncreaseIncreasediversificationdiversification
Reshape firm’sReshape firm’scompetitive scopecompetitive scope
Lower risk comparedLower risk comparedto developing newto developing new
productsproducts
Learn and developLearn and developnew capabilitiesnew capabilities
MergersMergers
Classification of MergersClassification of Mergers Horizontal MergersHorizontal Mergers Vertical MergerVertical Merger Market Extension MergerMarket Extension Merger Product extension MergerProduct extension Merger Concentric MergerConcentric Merger
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CLASSIFICATIONS OF CLASSIFICATIONS OF MERGERSMERGERS Horizontal mergerHorizontal merger - - Two companies that are in direct Two companies that are in direct
competition and share similar product lines and markets.competition and share similar product lines and markets.
Vertical mergerVertical merger - - A customer and company or a supplier A customer and company or a supplier and company. Think of a cone supplier merging with an ice and company. Think of a cone supplier merging with an ice cream maker.cream maker.
Market-extension mergerMarket-extension merger - - Two companies that sell Two companies that sell the same products in different markets.the same products in different markets.
Product-extension mergerProduct-extension merger - - Two companies selling Two companies selling different but related products in the same market.different but related products in the same market.
ConglomerationConglomeration - - Two companies that have no common Two companies that have no common business areas.business areas.
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Distinction between Distinction between Mergers and AcquisitionsMergers and Acquisitions
When one company takes over the When one company takes over the other and the target ceases to exist.other and the target ceases to exist.
In a MERGER 2 firms of same size In a MERGER 2 firms of same size decide to go forward as a new decide to go forward as a new company. – Merger of equalscompany. – Merger of equals
Mergers are often friendly while Mergers are often friendly while acquisitions are hostile - usually.acquisitions are hostile - usually.
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Top 12 Indian cross border acquisitions Top 12 Indian cross border acquisitions Sr. Acquisition Country Deal Size
1. Tata Group Acquired Corus, Oct. 2006 United Kingdom $12.98 billion
2. Bharti Airtel acquired Zain Africa, Feb 2010 Kenya $10.7 billion
3. Hindalco Industires acquired Novelis , Feb 2007 Canada $5.73 billion
4. ONGC acquired Kashagan Oilfields, November 2012 Kazakhstan $5 billion
5. ONGC acquired Imperial Energy, August 2008 United Kingdom $2.62 billion
6. Tata Motors acquired Jaguar Cars and Land Rover March 2008
United Kingdom $2.3 billion
7. Tanti Group of Companies and Arcapita Bank BSCc acquired Honiton EnergyApril 2010
China $2 billion
8. Adani Enterprises acquired Port Terminals, May 2011 Australia $1.97 billion
9. Essar Global acquired Algoma Steel, April 2007 Canada $1.79 billion
10. Reliance Industries acquires Oil & Gas Assets (Marcellus Shale), April 2007
United States $1.7 billion
11. Indian Hotels Co acquired Orient-Express Hotels, October 2012
Bermuda $1.67 billion
12. Essar Global acquired Minnesota Steel, April 2007 United States $1.65 billion
World's largest steel maker and the third richest man in World's largest steel maker and the third richest man in the world.(the world.(after Bill Gates and Warren Buffet)• Mittal Steel is the largest steel maker in the
world. • After the merger between Mittal Steel and
Arcelor which raged a big debate throughout the Europe, Laxmi Mittal current controls 10% of the global steel production
• The combined entity post-merger is three times the size of its nearest competitors. Lakshmi Mittal :Born on
June 15, 1950 at Sadulpur, in Churu district of Rajasthan, in a poor family.
Kensington mansion
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Testing the Gains of MergerTesting the Gains of Merger Product market test Product market test
• effect of mergers directly on consumers and effect of mergers directly on consumers and indirectly on stockholders of merging firms.indirectly on stockholders of merging firms.
Stock market test. Stock market test. • effect of mergers directly on stockholders of effect of mergers directly on stockholders of
merging firms and indirectly on consumers. merging firms and indirectly on consumers. There is a linkage between the two.There is a linkage between the two.
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Alternative ways to measureAlternative ways to measure Event StudiesEvent Studies
• compare stock prices of the firms a compare stock prices of the firms a certain days before and after the certain days before and after the mergers.mergers.
Regression AnalysisRegression Analysis• tax rate of return as dependant variable tax rate of return as dependant variable
and Size of the firm, rate of increase in and Size of the firm, rate of increase in capital stock, R&D capital stock, R&D expenditures etc. as expenditures etc. as independant variables.independant variables.
T TestT Test• Paired two samples for meanPaired two samples for mean
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Quantitative Measurement of success Quantitative Measurement of success of mergerof merger
Logic of test Remarks
Addition of profits of both companies after merger to be higher than any one before merger.
Addition is child’s play. The synergy should drive the profit accrual much more than that.
Cost of production to produce per rupee sale
Economies of scale should drive the cost down due to better bargaining.
Net Profit Margin Cost saving and economies of scale should drive up the profit ratio.
Net Profit/Share Capital incl. Free reserves The ultimate translation of objective of any business.
Net Profit + Depreciation / Capital Cash profits translate better
Net Profit / Total of Balance sheet How you have managed your total assets
fayada
huAa
@yaa?
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Who is this and are these Who is this and are these acquisitions or mergersacquisitions or mergers
Originated in Burma in 1890s (Mynamar)Originated in Burma in 1890s (Mynamar) Started as moneylender but by independence entered into Started as moneylender but by independence entered into
insurance, rubber, stockbroking, textiles. insurance, rubber, stockbroking, textiles. 1949 Collaborated with UK’s Tube investments to form Tube 1949 Collaborated with UK’s Tube investments to form Tube
Investments of India – BicyclesInvestments of India – Bicycles Vertically integrated into tubes, strips, lamps & chainsVertically integrated into tubes, strips, lamps & chains 1954 Carborandum Universal association with Carborandum 1954 Carborandum Universal association with Carborandum
USA. Later made its own Raw Material (Bauxite) mining etc. USA. Later made its own Raw Material (Bauxite) mining etc. 1979 Floated Public issues to implement expansion strategies1979 Floated Public issues to implement expansion strategies 1981 acquired EID Parry having diversified base – ceramic, 1981 acquired EID Parry having diversified base – ceramic,
confectionery, fertilisers, electronics. Turned it around.confectionery, fertilisers, electronics. Turned it around. Ventured into new businesses like bio pesticides, ceramic Ventured into new businesses like bio pesticides, ceramic
colour, Information Technologycolour, Information Technology The only Indian Company to win IMD award in 2001 for Best The only Indian Company to win IMD award in 2001 for Best
run Family Business. run Family Business. 3131
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The major companies of the Group are:
Carborundum Universal Limited Cholamandalam DBS Finance Limited
Cholamandalam MS General Insurance Coromandel Fertilisers Limited
EID Parry India Limited Tube Investments of India Limited
Parry Agro Industries Limited
Ambadi Enterprises Ltd Cholamandalam Distribution Services Ltd
Cholamandalam Mutual Cholamandalam MS Risk Services Ltd (CMSRSL)
Cholamandalam Securities Ltd Coromandel Engineering Company Ltd
Kadamane Estates Company Laserwords Pvt Ltd
Murugappa Morgan Thermal Ceramics Ltd Net Access India Pvt Ltd
New Ambadi Estates Pvt Ltd Parry Enterprises India Ltd
Parry Murray and Co Ltd Placon (India) Pvt Ltd
Polutech Ltd Prodorite Anticorrosives Ltd
Southern Energy Development Corporation Sterling Abrasives Ltd
Wendt India Ltd 3333
AcquisitionsAcquisitions
Problems With AcquisitionsProblems With Acquisitions
IntegrationIntegrationdifficultiesdifficulties
InadequateInadequateevaluation of targetevaluation of target
High degree of LeverageHigh degree of Leverage
Inability toInability toachieve synergyachieve synergy
Too muchToo muchdiversificationdiversification
Managers overlyManagers overlyfocused on acquisitionsfocused on acquisitions
Resulting firmResulting firmis too largeis too large
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Shaking off Hostile Take over Shaking off Hostile Take over Shark Shark repellentsrepellents
Corporate Restructuring Corporate Restructuring
Options are similar to voluntary restructuring but more immediate.Options are similar to voluntary restructuring but more immediate. Actions designed to thwart the takeover.Actions designed to thwart the takeover.
• Involuntary restructuring (tender offer)Involuntary restructuring (tender offer)
- FinancialFinancial
• Poison pills Poison pills • Leveraged recapitalizationsLeveraged recapitalizations• GreenmailGreenmail• LitigationLitigation
- AssetAsset• Scorched earth defense - defensive asset restructuringScorched earth defense - defensive asset restructuring• Crown jewel sales - sell sought after unitCrown jewel sales - sell sought after unit• Pac-man defense - target launches attempt to acquire bidderPac-man defense - target launches attempt to acquire bidder
- Third Party- Third Party
• White knight defenseWhite knight defense• Other bidder (competitive bid situation)Other bidder (competitive bid situation) 3535
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Recent Indian experience
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Valuation for takeover Valuation for takeover Book valueBook value
Liabilities Rs. Cr. Assets Rs. Cr.
Share Capital 100 Fixed Assets 300
Reserves 280 Investments 25
Creditors 32 Stock 10
Provisions 5 Debtors 85
Misc exp 7
Total 417 Total 417
Net Assets (100+280) = 380Net Assets (100+280) = 380
Valuation for takeover Valuation for takeover Market valueMarket value
Liabilities Rs. Cr. Assets Rs. Cr.
Share Capital 100 Fixed Assets 900
Reserves 887 Investments 12
Creditors 22 Stock 10
Provisions 5 Debtors 85
Misc exp 7
Total 1014 Total 1014
Net Assets (100+887) = 987Net Assets (100+887) = 987
Valuation for takeover Valuation for takeover Market value + Market value + BrandBrand
Liabilities Rs. Cr. Assets Rs. Cr.
Share Capital 100 Brand 10
Reserves 897 Fixed Assets 900
Creditors 22 Investments 12
Provisions 5 Stock 10
Debtors 85
Misc exp 7
Total 1024 Total 1024
Net Assets (100+897) = 997Net Assets (100+897) = 997
Valuation for takeover Valuation for takeover Market value + Brand+ adj for streamliningMarket value + Brand+ adj for streamlining
Rs. Cr Rs. Cr.
Net asset value (prev. slide) 997
New Machinery 80
Less Scrap value of old 5
Net new machinery 75
Disputed debtors 12 (89)
Value offered by purchaser 908
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BBrand rand VValuationaluation (Intellectual Property Assets)
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What is a BrandWhat is a BrandThe brand is a special intangible that in manybusinesses is the most important asset.
Brand has to be registered to hold value.
Some brands have also demonstrated an astonishing Durability. The world’s most valuable brand, Coca-Cola, is more than 118 years old.
Majority of the world’s most valuable brands havebeen around for more than 60 years. Compare this with the average life of the Corporation of 25 years.
Valuation of Firm or Brand?Valuation of Firm or Brand?
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Firm level approaches measure the brand as a financial asset. In short, a calculation is made regarding how much the brand is worth as an intangible asset. i.e.
Firm Level
Product LevelCompare the price of a no-name or private label product to an "equivalent" branded product. The difference in price, assuming all things equal, is due to the brand
Consumer Level
Measure the awareness (recall and recognition) and brand image (the overall associations that the brand has). Free association tests and projective techniques are commonly used to uncover the tangible and intangible attributes, attitudes, and intentions about a brand. Brands with high levels of awareness and strong, favorable and unique associations are high equity brands[.
Mkt cap – (tang.assets +measurable intangible assets)= brand equity.
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IP as a component of ICIP as a component of IC
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Intellectual Capital
Human Capital
Relational Capital
Organisational Capital
Intellectual Property
“Sociological” Skills and
Capital
“Technological” Skills and
Competencies
Infrastructure Capital
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Organisational (structural) capital: Organisational (structural) capital: examples of IPexamples of IP
• • patentspatents
• • copyrightscopyrights
• • design rightsdesign rights
• • trade secretstrade secrets
• • trade markstrade marks
• • service marksservice marks
• • trade dresstrade dress
• • utility modelsutility models
• • plant & seed varietiesplant & seed varieties 4646
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Why Value Intellectual CapitalWhy Value Intellectual Capital
Measurement of IC - enables a more efficient Measurement of IC - enables a more efficient management of the company - i.e. to:management of the company - i.e. to:understand where value lies in the companyunderstand where value lies in the companyhave a metric for assessing success and growthhave a metric for assessing success and growthprovide a basis for raising finance or loansprovide a basis for raising finance or loans
If borrowing can only be secured against If borrowing can only be secured against tangible assets, then knowledge-based tangible assets, then knowledge-based companies will be disadvantaged in companies will be disadvantaged in investment and growth.investment and growth.
Brand ValueBrand Value Brand equityBrand equity refers to the marketing effects or refers to the marketing effects or
outcomes that accrue to a product with its brand outcomes that accrue to a product with its brand name compared with those thatname compared with those that would accrue if would accrue if the same product did not have the brand name. the same product did not have the brand name.
The study of brand equity is increasingly popular The study of brand equity is increasingly popular as some marketing researchers have concluded as some marketing researchers have concluded that brands are one of the most valuable assets that brands are one of the most valuable assets that a company has.that a company has.
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Top Indian Brands of 2013 (Economic Times)
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Top Global Brands of 2013 Page 19 of
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In the beginning……In the beginning…… Goodwill Goodwill (Nestlé’s purchase of Rowntree, Grand (Nestlé’s purchase of Rowntree, Grand
Metropolitan pur. of Pilsbury)Metropolitan pur. of Pilsbury)• Did not qualify for lendingDid not qualify for lending• Had to be amortizedHad to be amortized• Drained P & LDrained P & L• Residual assets lower than at takeover Residual assets lower than at takeover
UK & France left grey areasUK & France left grey areas• Reckitt & Colman (UK)put a value on its balance sheet for the Reckitt & Colman (UK)put a value on its balance sheet for the
Airwick brandAirwick brand
First brand independent valuation First brand independent valuation • Rank Hovis McDougall (RHM) defensive tactics to thwart Rank Hovis McDougall (RHM) defensive tactics to thwart
takeover by Goodman Fielder Wattie (GFW).takeover by Goodman Fielder Wattie (GFW). In In 19891989 London Stock Exchange endorsed concept London Stock Exchange endorsed concept
of brand valuation as used by RHM in class test for of brand valuation as used by RHM in class test for shareholder approval during take-overs shareholder approval during take-overs 5151
Mid 80’s
1988
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Accounting concernsAccounting concerns
Is the intangible asset clearly Is the intangible asset clearly identifiableidentifiable
Does the company hold an Does the company hold an unambiguous title to the assetunambiguous title to the asset
Could the intangible asset be sold Could the intangible asset be sold separately from the businessseparately from the business
Does the intangible give rise to a Does the intangible give rise to a “premium” not earned by other “premium” not earned by other companies?companies?
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Separable Not separable
Wholly tangible (i.e. machine tool)
Highly intangible (i.e. goodwill)
Tangibility and Separability: the Spectrum of Assets
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Accounting approaches to valuation Accounting approaches to valuation Cost based valuationCost based valuation
historical creation cost - how much did it cost to create?historical creation cost - how much did it cost to create? current recreation cost - how much would it cost to current recreation cost - how much would it cost to
recreate an identical intangible?recreate an identical intangible?
Market based valuation - evidence from sale or Market based valuation - evidence from sale or purchase of similar assets (i.e. individual brands, purchase of similar assets (i.e. individual brands, branded divisions or whole companies)branded divisions or whole companies)
Income based valuation looks at the stream of Income based valuation looks at the stream of income attributable to the intangible asset, based income attributable to the intangible asset, based on:on: historical earnings (i.e. multiple of earnings)historical earnings (i.e. multiple of earnings) expected future earnings (i.e. discounted cash flow)expected future earnings (i.e. discounted cash flow)
Financial Financial ApproachApproach
Financial Valuation break-upFinancial Valuation break-up
Cost Based Cost Based ComparablesComparables
Premium PricePremium Price
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aggregation of all historic costs incurredaggregation of all historic costs incurred
OrOr replacement costs required in bringing the brand to its replacement costs required in bringing the brand to its
current state current state
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Cost Based Cost Based
Brand cost=Dev.Cost + Mktng +Advert.+ Comm. +Others.
DisadvantageThere is NO Direct correlation between financial investment made & value added.
Interesting cross-checkInteresting cross-check Never be relied on solely for valuing brandsNever be relied on solely for valuing brands
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ComparablesComparables
Compare the price of a no-name or private label product to an "equivalent" branded product. The difference in price, assuming all things equal, is due to the brand
Comparable?
Comparable?
&
&
The value is calculated as the net present value of future The value is calculated as the net present value of future price premiums that a branded product would command price premiums that a branded product would command over an unbranded or generic equivalent.over an unbranded or generic equivalent.
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Premium PricePremium Price
Brand cost=NPV (Target Brand price-Other Brand price)
Primary purpose of many brands ≠ price premium
but rather to secure the highest level of future demand. The value generation of these brands lies in securing future volumes rather than securing a premium price.
Disadva
ntage
A : No B: Yes
D : It cannot be sold therefore it is not a brand
Is CID Most Wanted one of the popular TV shows, a brand?
C : It is not a product or a service so it is not a brand
50/50
B: Yes
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Cost Based Cost Based
Brand cost=Dev.Cost + Mktng +Advert.+ Comm. +Others.
Cost Based Cost Based estimate = Rs. 712 lacs estimate = Rs. 712 lacs
Description Rs. In lacs Rs. In lacs
Cost of formula (20,000 X 62) 12.40
Advertising (2 crores X 3) 600.00
POS Cost 100.00
TOTAL BRAND COST 712.40
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ComparablesComparables
Compare the price of a no-name or private label product to an "equivalent" branded product. The difference in price, assuming all things equal, is due to the brand
Description calculation Rs. /NosDifference in price 12 – 10 2Difference in monthly units sold 300– 40 (000) 2,60,000Premium monthly sales 2,60,000 X 2 Rs. 5,20,000Premium annual sales Rs. 5,20,000 X 12 Rs. 62,40,000Premium sales for 5 years Rs. 62,40,000 X 5 Rs. 312 lacs
Do you not think that the sales over the next five years should be calculated at the present value?
Comparables based Comparables based estimate = Rs. 312 lacsestimate = Rs. 312 lacs
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ComparablesComparables
Calculate the present value (PV) of future cash flows for a justified as well as a balanced perspective. Rate of PV may be debatable. Let us take it at 9% being the average expected inflation rate
Year Premium Sales PV @ 9% PV X Sales Rs. In Lacs Rs. In Lacs
1 62.40 1.092 62.40 1.193 62.40 1.304 62.40 1.415 62.40 1.54
Total
Premium PricePremium Price
Brand cost=NPV (Target Brand price-Other Brand price)
Premium PricePremium PriceEstimated Rs. 417.38 lacsEstimated Rs. 417.38 lacs
68.0274.26 81.1287.98 96.10
417.38
Interbrand MethodologyInterbrand Methodology
Income approach Relief-from-Royalty Method
Estimate revenues attributable to the IP over its economic life.
Easy and common, but can be misleading if not applied carefully
Step 1Step 1
Step 2Step 2
Step 3Step 3
Step 4Step 4
Step 5Step 5
Estimate of an arm's length royalty rate be paid for the use of comparable IP.
Apply concluded royalty rate to the projected sales of the brand over its economic life.
Apply an appropriate cash tax charge in each period to estimate the after tax royalty savings.
Discount to present value the after tax royalty savings stream.
Royalty rate determinants Excess operating profit attributable to the brand Market comparable royalty rates The nature of the licence The strength and importance of this intangible
asset The geographical scope of the licence The need for both parties to secure a satisfactory
return The probable level of continuing sales The commercial obligations undertaken The relative negotiating strengths of each party
Acquisition / Merger Acquisition / Merger Impact on the Stock Impact on the Stock
Exchange Exchange
Acquisition of Stock (Equity)Acquisition of Stock (Equity)
Price / earnings ratio 16 12
Example Example -- Company A will acquire Company B with shares of common stock.
All amounts in Rs. Acquirer Co. Target Co.
Present earnings (PAT) 2,00,00,000 50,00,000
Shares outstanding 50,00,000 20,00,000
Earnings per share 4.00 2.50
Price per share 64.00 30.00
Exchange ratio determinationExchange ratio determinationAssuming Target company has accepted offer of Assuming Target company has accepted offer of
Rs. 35 per shareRs. 35 per share
Shares outstanding50,00,000 + 10,93,750*
60,93,750
Merged Company
Total Earnings (Add both company earnings) 2,50,00,000
Earnings per share 4.10
* New shares from exchange New shares from exchange = .546875.546875 x 20,00,000 = 10,93,75010,93,750
Exchange ratio = Rs.35 / Rs.64 = .546875.546875
Impact on shareholdersImpact on shareholders
The shareholders of Company A will experience an increase in earnings per share because of the acquisition [Rs.4.10 post-merger EPS versus Rs. 4.00 pre-merger EPS].
The shareholders of Company B will experience a decrease in earnings per share because of the acquisition [.546875 x Rs.4.10 = Rs.2.24 post-merger EPS versus Rs.2.50 pre-merger EPS].
Exchange ratio determinationExchange ratio determinationAssuming Target company has accepted offer of Assuming Target company has accepted offer of
Rs. 45 per shareRs. 45 per share
Shares outstanding50,00,000 + 14,06,250*
64,06,250
Merged Company
Total Earnings (Add both company earnings) 2,50,00,000
Earnings per share 3.90
* New shares from exchange New shares from exchange = .703125 .703125 x 20,00,000 = 14,06,25014,06,250
Exchange ratio = Rs.45 / Rs.64 = .703125.703125
Impact on shareholdersImpact on shareholders The shareholders of The shareholders of Company A will will
experience a experience a decrease in earnings decrease in earnings per share per share because of the acquisition [Rs. .90 post-merger because of the acquisition [Rs. .90 post-merger EPS versus Rs. 4.00 pre-merger EPS].EPS versus Rs. 4.00 pre-merger EPS].
The shareholders of The shareholders of Company B will will experience experience an increase in earnings per share per share because of the acquisition [.703125 x Rs.4.10 = because of the acquisition [.703125 x Rs.4.10 = Rs.2.88 post-merger EPS versus Rs.2.50 pre-Rs.2.88 post-merger EPS versus Rs.2.50 pre-merger EPS].merger EPS].
What about EPSWhat about EPS
With theWith themergermerger
Without theWithout themergermerger
Exp
ect
ed
EPS
(R
s.)
Equal
Time in the Future (years)
Initially, EPS is less with the merger.
Eventually, EPS is greater with the merger.
Merger decisions Merger decisions should not be made should not be made without considering without considering the long-term the long-term consequences.consequences.
The possibility of The possibility of future earnings future earnings growth may outweigh growth may outweigh the immediate the immediate dilution of earnings.dilution of earnings.
Ratio of exchange of market price.Ratio of exchange of market price.
Market price per shareMarket price per shareof the acquiring companyof the acquiring company X
Number of shares offered bythe acquiring company for eachshare of the acquired company
Market price per share of the acquired companyMarket price per share of the acquired company
If the ratio is less than or nearly equal to 1, the If the ratio is less than or nearly equal to 1, the shareholders of the acquired firm are shareholders of the acquired firm are not likely not likely to have a monetary incentive to accept the to have a monetary incentive to accept the merger offer from the acquiring firm.merger offer from the acquiring firm.
What is LBOWhat is LBOLeveraged Buy-out is a Company Acquisition MethodLeveraged Buy-out is a Company Acquisition Method A LBO is a A LBO is a company acquisition methodcompany acquisition method by which by which
a business can seek to a business can seek to takeovertakeover another company another company or at least or at least gain a controlling interestgain a controlling interest in that in that company. company. Special about leveraged buy-outs is that the corporation that is Special about leveraged buy-outs is that the corporation that is buying the other business borrows a significant amount of money to pay for (the buying the other business borrows a significant amount of money to pay for (the majority of) the purchase price (usually over 70% or more of the total purchase majority of) the purchase price (usually over 70% or more of the total purchase price). price).
The debt which has been incurred is secured against The debt which has been incurred is secured against the assets of the business being purchased. the assets of the business being purchased.
Interest payments on the loan will be paid from the Interest payments on the loan will be paid from the future cash-flow of the acquired company. future cash-flow of the acquired company.
popular in the 1980s,
LBO DefinedLBO Defined A A leveraged buyoutleveraged buyout (or (or LBOLBO, or highly-leveraged , or highly-leveraged
transaction (HLT), or "bootstrap" transaction) occurs transaction (HLT), or "bootstrap" transaction) occurs when a financial sponsor acquires a controlling interest when a financial sponsor acquires a controlling interest in a company's equity and in a company's equity and
where a significant percentage of the purchase price is where a significant percentage of the purchase price is financed through leverage (borrowing). financed through leverage (borrowing).
The assets of the The assets of the acquired companyacquired company are used as are used as collateral for the borrowed capital, sometimes with collateral for the borrowed capital, sometimes with assets of the acquiring company. assets of the acquiring company.
The bonds or other paper issued for leveraged buyouts The bonds or other paper issued for leveraged buyouts are commonly considered not to be investment grade are commonly considered not to be investment grade because of the significant risks involved.because of the significant risks involved.
Figurative representation of LBOFigurative representation of LBO
Normal targets of LBOsNormal targets of LBOs Low existing debt loads; Low existing debt loads;
A multi-year history of stable and recurring cash flows; A multi-year history of stable and recurring cash flows;
Hard assets (property, plant and equipment, inventory, Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost receivables) that may be used as collateral for lower cost secured debt; secured debt;
The potential for new management to make operational The potential for new management to make operational or other improvements to the firm to boost cash flows; or other improvements to the firm to boost cash flows;
Market conditions and perceptions that depress the Market conditions and perceptions that depress the valuation or stock price. valuation or stock price.
RationaleRationale The use of debt increases (leverages) the The use of debt increases (leverages) the
financial return to the private equity sponsor. As financial return to the private equity sponsor. As the debt in an LBO has a relatively fixed, albeit the debt in an LBO has a relatively fixed, albeit high, cost of capital, any returns in excess of this high, cost of capital, any returns in excess of this cost of capital flow through to the equity. cost of capital flow through to the equity.
The tax shield of the acquisition debt.The tax shield of the acquisition debt.
Advantages of LBOAdvantages of LBO1.1. Low capital or cash requirementLow capital or cash requirement for the acquiring entity for the acquiring entity
2.2. Synergy gainsSynergy gains, by expanding operations outside own industry or , by expanding operations outside own industry or business,business,
3.3. Efficiency gainsEfficiency gains by eliminating the value-destroying effects of by eliminating the value-destroying effects of excessive diversification,excessive diversification,
4.4. Improved Leadership and ManagementImproved Leadership and Management. Takeovers weed out or . Takeovers weed out or discipline rogue managers. discipline rogue managers.
5.5. LeveragingLeveraging: as the debt ratio increases, the equity portion of the : as the debt ratio increases, the equity portion of the acquisition financing shrinks to a level at which a private equity firm acquisition financing shrinks to a level at which a private equity firm can acquire a company by putting up anywhere from 20-40% of the can acquire a company by putting up anywhere from 20-40% of the total purchase price.total purchase price.
Weakness of LBOWeakness of LBO1.1. Exploiting wealth of third partyExploiting wealth of third party
2.2. Interest payments are tax deductible so Government looses Interest payments are tax deductible so Government looses on revenueon revenue
3.3. Risk of management and shareholder confrontation will impair Risk of management and shareholder confrontation will impair the success of the LBO.the success of the LBO.
4.4. Risk is effectively transferred to the Financer who has only Risk is effectively transferred to the Financer who has only interest compensation for the risk; making the equation unfair.interest compensation for the risk; making the equation unfair.
5.5. Most of the LBOs were for asset stripping which is frowned Most of the LBOs were for asset stripping which is frowned upon by mature corporate.upon by mature corporate.
6.6. Structuring a LBO document for a financer is difficult in the Structuring a LBO document for a financer is difficult in the Indian Legal Environment. Indian Legal Environment.
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