Measuring Success of Mergers and Acquisitions

Submitted bySamarpita

Raj VardhanArchana

RaghuramSreekanth A S

Measuring success of mergers and acquisitions

CONTENTS

mergers And Acquisitions........................................................................................................................................ 1

Reasons For Mergers And Acquisitions..............................................................................................................2

What Measure Success?............................................................................................................................................ 2

A Summary Of The Recent Studies......................................................................................................................4

Failure In A Nutshell.................................................................................................................................................. 5

Reasons For Success...................................................................................................................................................6

People And Cultural Factors....................................................................................................................................7

Shareholder Value Maximization:.........................................................................................................................8

Tata Steel’s Acquisition Of Corus.........................................................................................................................8

Reasons For Tata Steel To Bid:..........................................................................................................................8

Reasons For Corus To Be Sold:.........................................................................................................................9

Analysis Of Tata – Corus Case...............................................................................................................................9

Return On Net Worth.............................................................................................................................................9

Market Value Added........................................................................................................................................... 10

Ratio Analysis....................................................................................................................................................... 11

Eva Calculation..................................................................................................................................................... 12

Conclusion.................................................................................................................................................................. 13

Bibliography.............................................................................................................................................................. 14

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Measuring success of mergers and acquisitions

MERGERS AND ACQUISITIONS

Mergers and acquisitions or M&A  are both means by which two or more business entities

become one larger entity. In the case of a merger, this is often a process that is entered into after

a long period of evaluation on the part of the respective officers and owners of the companies

involved. When the idea is to merge companies together, there is usually a sense that all parties

involved in the creation of the new and larger entity are equals in the process and will be treated

as such as the structure of the new entity is planned and put into operation.

With an acquisition, the scenario is a little different. When one company decides to acquire

another company, the process usually involves a buyout or purchase of that business. There are

not necessarily any plans to continue all the operations of the acquired company; often the

resources of the acquisition are absorbed into the resources held by the purchasing company

while the acquired business simple ceases to exist.

Mergers and acquisitions also tend to differ in one other important aspect. While mergers are

generally situations where all parties want the combination of companies to take place that is not

necessarily the case with an acquisition. Hostile takeovers are an example of an acquisition that

is not accomplished with the enthusiastic support of the officers and shareholders of the acquired

business. At best, there may be a sense of grudging acceptance that the takeover will occur

whether or not shareholders and officers want the acquisition.

REASONS FOR MERGERS AND ACQUISITIONS

Economies of scale through larger productive capacity or ability to share services

Vertical integration of productive capacity or the supply chain

Market share / elimination of direct or indirect competition

Securing supply

Asset acquisition or stripping

Strategic hedging through addition of counter cyclical products to the group mix

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Measuring success of mergers and acquisitions

Acquisition of access to Intellectual Property

Geographic expansion or access to markets with entry barriers

Accumulation of complimentary product/service sets

Suppression of emerging product line / Intellectual Property threats

Acquisition of customers

WHAT MEASURE SUCCESS?

The most obvious outcome of any M&A is prima-facie the elimination of an actual or potential

competitor from the competitive mix.

In 1999 KPMG published a study of merger outcomes over the preceding 10 years. The study

identified that 75% to 83% of mergers fail where failure was measured by lower productivity,

labor unrest, higher absenteeism & loss of shareholder value or even dissolution of companies.

This and other studies highlight a central question in determining the strategy for a successful

merger - what is the basis for measuring the success of an M&A project?

Success Measure Survey Outcome Year of Study

Achievement of anticipated purpose 30-45% 1997

Achievement of strategic or financial object <20% 1983, 1991, 1994

Preserve or Enhance book value 25%-45% 1988, 1999

Enhance shareholder value 17% 1995

Preserve or improve NPAT <50% 1996, 1999

Preserve or improve productivity <25% 1988, 1999

Preserve strike, absenteeism and accidents levels <50% 1977, 1981, 1999

Financially advantageous in Long Term 20-50% 1978, 1988, 1999

Financially advantageous in Short Term 50% 1996

 Zweig (1995) and KPMG (1999) study found in their respective studies of merger outcomes that

on 17% of mergers resulted in an enhancement of either shareholder value or key performance

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Measuring success of mergers and acquisitions

drivers.  Zweig found that shareholder value was actually destroyed in 53% of cases, and KPMG

determined the performance drivers actually weakened in 78% of cases:

A SUMMARY OF THE RECENT STUDIES

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Measuring success of mergers and acquisitions

Integration of the pre-merger businesses in the post-merger entity is a precursor to success in the

majority of merger strategies.

Reason  %

1 Poorly planned and managed integration 100

2 Neglect of existing business due to the attention being paid to the acquired business 68

3 Underestimating the depth & pervasiveness of human issues triggered by the merger 50

4 Loss of key staff in acquired business 50

5 Demotivation of employees of acquired business 50

6 Underestimating problems of skill transfer 34

7 Selecting the wrong partner 34

8 Cultural incompatibility 17

9 Delayed decisions due to breakdown of responsibilities, delegations & authority 17

10Too much focus on doing the deal - not enough on to integration planning &

management17

11 Insufficient research (due diligence) into the acquired business 17

12 Paying the wrong price or at the wrong time 17

13 Buying for the wrong reasons 17

14 Incompatible business and IT systems JB

15 Doomed by negotiationJB

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Measuring success of mergers and acquisitions

FAILURE IN A NUTSHELL

Where business integration is a key ingredient of the post-merger mix, the studies allow us to

identify the top 5 risks of that result in merger failure:

1. Integration poorly planned and managed

2. Underestimated cultural & human risks

3. Loss of key success enablers (e.g.: staff)

4. Inaccurate financial due diligence

5. Neglecting current business

As these studies examined mergers that actually completed (i.e. the takeover survived the

acquisition process), the studies ignored a common reason for merger failure: That of non-

completion. Reasons for non-completion might include:

1. Legal (non-participating competitor) or regulatory intervention

2. Unacceptable risks, asset/liability valuations or cultural issues emerging during sue-

diligence

3. Exogenous market shifts during the merger process (such as changes in market conditions

of demand, financing, etc.)

4. Death or departure of key personnel from the target entities

5. Excessive regulatory or judicial hurdles causing the process to extend unacceptably for

the participants

6. Failure, or inability to offer sufficient compensation to the vendors

7. Gazumping by competitor acquirers

REASONS FOR SUCCESS

Conversely both formal studies and deductive reasoning allows us to identify the key reasons for

successful mergers.

No need to achieve an integrated business, and "right" price paid

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Measuring success of mergers and acquisitions

Nature of post-merger structure (vertical, conglomerate or geographic, etc.)

Clearly enunciated & communicated direction

Acquisition-specific & flexible integration strategy

Clear decision structure and role definitions

A sense of urgency and outcome ownership

Compatible business systems

Compatible business cultures

Compatible accounting practices

Integration ready culture

Commonality of merger goals

Active risk management strategy

Actively managed, tracked & resourced integration project

Minimized debt service load

Pre-existing partnering or cohabitation

PEOPLE AND CULTURAL FACTORS

According to a KPMG study, "83% of all mergers and acquisitions (M&As) failed to produce

any benefit for the shareholders and over half actually destroyed value". Interviews of over 100

senior executives involved in these 700 deals over a two-year period revealed that the

overwhelming cause for failure "is the people and the cultural differences" The cultural

incompatibility is the single largest cause of lack of projected performance, departure of key

executives, and time consuming conflicts in the consolidation of business. Culture plays a vital

role in the way how employees react to the new organization culture environment. The term

‘Culture clash’ has been coined to describe the conflict of two companies’ philosophies, styles,

values, and missions. This may, in fact, be the most dangerous factors when two companies

decide to combine. Even in the best circumstances, mergers can so change the nature, orientation

and character of one or both of the merger partners; this means five to seven years are typically

required for employees to feel truly incorporated into a merged entity. Due to the multitude of

these changes, the post-merger period witnesses many problems. Most of these adjustments

problems arise from employees’ fears regarding the loss of job, also financial debt regarding job

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Measuring success of mergers and acquisitions

loss. Moving into the realm of the unknown with a new manager and a new team is also

distressing and anxiety provoking. Other fears include the loss of effective and close team

members, as well as the uncertainty about the new team members and supervisors to be

inherited. When forced to deal with new team members and supervisors, employees may

frequently develop fears of taking risks and raising sensitive subject. This may adopt ‘us verses

them’ thinking, where trust for the new team members will be minimal. Corporations facing this

kind of behavior may have to pay the high price of loss of cooperation and initiative among the

employees of the new business combination. The synergies that were initially sought may be

harder to achieve, conflicts and disagreement will be more difficult to resolve, if at all, and this

friction occur more frequently, post-merger will be the most difficult time for the new team to

move forward as a whole.

SHAREHOLDER VALUE MAXIMIZATION:

Broad measures comprising the value added twins, namely, economic value added (EVA)

and Market Value Added (MVA).

The traditional measure of Return on Net worth (RONW).

We identified three important factors which show the success or failure of M&A. The factors

are:

Economic value Added(EVA)

Market value Added (MVA)

Return on Net Worth(RONW)

As part of the study we have done a comparative study between of pre-merger period and post-

merger period of TATA steel and Corus.

TATA STEEL’S ACQUISITION OF CORUS

The deal (between Tata & Corus) was officially announced on April 2nd, 2007 at a price of 608

pence per ordinary share in cash. This deal is a 100% acquisition and the new entity will be run

by one of Tata’s steel subsidiaries. As stated by Tata, the initial motive behind the completion of

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Measuring success of mergers and acquisitions

the deal was not Corus’ revenue size, but rather its market value. Even though Corus is larger in

size compared to Tata, the company was valued less than Tata (at approximately $6 billion) at

the time when the deal negotiations started. But from Corus’ point of view, as the management

has stated that the basic reason for supporting this deal were the expected synergies between the

two entities. Corus has supported the Tata acquisition due to different motives. However, with

the Tata acquisition Corus has gained a great and profitable opportunity to make an exit as the

company has been looking out for a potential buyer for quite some time.

REASONS FOR TATA STEEL TO BID:

To tap European Mature Market

Cost of acquisition is lower than setting up of Green field plant & marketing and

distribution channel.

Tata manufactures low value, long and flat steel products, while Corus produce high

value stripped products

Helped Tata to feature in Top 10 players in the World.

Technology Benefit

Economy of scale

Corus holds number of patents and R & D facilities.

REASONS FOR CORUS TO BE SOLD:

A chance to bail out of Debt and Financial stress.

Access to cheap and high quality iron ore from India

Corus has high cost of production

Though Corus had revenues of $ 18.06 bn, its profit was just $ 626 mn(Tata’s revenue

was $ 4.84 bn and profit $ 824 mn)

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Measuring success of mergers and acquisitions

ANALYSIS OF TATA – CORUS CASE

RETURN ON NET WORTH

Tata steel

Return on net

worth  ` in cr2005-06 Net worth 9755.3

PAT 3506.38

RONW 35.94%

2009-10

Net Worth 36961

PAT 5046.8

RONW 13.60%

Corus (2005-2006)

Return on net

worth

2005-06 Net worth 3934 mn Pounds

PAT 229 mn pounds

RONW 5.80%

Interpretation: Return on Net worth (RONW) is used in finance as a measure of company’s

Profitability. It reveals how much profit a company generates with the money that the

equity shareholders have invested. Therefore, it is also called return on Equity (ROE)

RONW considers only equity shareholding as the base for deciding efficiency of a

company’s operations.

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Measuring success of mergers and acquisitions

Pre-Acquisition-The RONW of Tata Steel pre-acquisition was more than that of Corus,

which means the shareholders of Tata Steel were getting more return on the equity

invested as compared to Corus.

Post-Acquisition-The RONW post acquisition has come to 13.60% which means that returns the

shareholders are getting is less when compared to the figures before acquisition.

MARKET VALUE ADDED

TATA Steel

MVA  ` in cr2005-06 Share price 536.5

Out. Shares 552801401

market value 296577951636.50

Capital employed 1.43639E+11

MVA 15293

MVA  ` in cr2009-10 Share price 632.00

Out. Shares 888126020.00

market value 561295644640.00

Capital

employed 642,327,800,000.00

MVA -8103.22

Interpretation: Market Value Added (MVA) is the difference between the current market value

of a firm and the capital contributed by investors. If MVA is positive, the firm has added value.

If it is negative, the firm has destroyed value. A high MVA indicates the company has created

substantial wealth for the shareholders. Negative MVA means that the value of the actions and

investments of the management is less than the value of the capital contributed to the company

by the capital markets. This means that the value or the wealth has been destroyed.

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Measuring success of mergers and acquisitions

Post-Acquisition-The value of MVA is negative for Tata steel, which means that the value of

the firm is destroyed post-acquisition.

RATIO ANALYSIS

2009-10(`) 2005-06(`)DPS 13 8

EPS 56.37 63.35

Net Profit margin 19.76 22.78

Interpretation: DPS -The amount of dividend that a stockholder will receive for each share of

stock held and used by most industry investors as a quick and simple indicator of the cash return

that an investor may expect. The increase in the dividend from `8 to `13 clearly indicates that the

company has grown well post acquisition.

EPS-The portion of a company's profit allocated to each outstanding share of common

stock. Earnings per share serve as an indicator of a company's profitability. Earnings per share

(EPS) are one of the most important measures of company strength. Obviously, the higher this

number, the more money the company is making. Tata steel has not been able to increase its

earnings post acquisition which can be interpreted from the data above.

NET PROFIT MARGIN-Net Profit Margin tells you exactly how the managers and operations of

a business are performing. Net Profit Margin compares the net income of a firm with total sales

achieved. There is a decline in the net profit margin post acquisition for Tata Steel which

indicates that it is not very effective in converting its sales into actual profit. This number is an

indication of how effective a company is at cost control. The higher the net profit margin is, the

more effective the company is at converting revenue into actual profit. The net profit margin is a

good way of comparing companies in the same industry, since such companies are generally

subject to similar business conditions.

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Measuring success of mergers and acquisitions

EVA CALCULATION (PRE AND POST ACQUISITION :( ` in crores))

ELEMENTS 2006-2007 2007-2008

Risk Free rate 8.00% 5.27%

Market Premium 6.50% 9.00%

Assumed Beta 1.12 1.5

Cost of Equity 15.28% 18.77%

Equity % 37.00% 35.00%

Cost of Debt 8.00% 8.00%

Tax rate 34.00% 25.00%

After tax cost of debt 5.28% 6.00%

Debt % 63.00% 65.00%

WACC 8.98% 10.4695%

Capital Employed 42074.75 92161.62

Net profit 4165.61 12321.76

Total weighted cost 3778.313 9648.871

EVA 387.297 2672.9

Interpretation of EVA: A measure of a company's financial performance based on the residual

wealth calculated by deducting cost of capital from its operating profit .EVA is measured by

comparing your Return on Capital Employed with our Cost-of-Capital, also called your “Return

Spread.” A positive Return Spread indicates we are earning more than your cost-of-capital which

means we are creating wealth for your owners or stockholders. A negative Return Spread means

we are earning less than your cost-of-capital, reducing the wealth of your owners and

stockholders.

Here post acquisition the value of EVA increased to a huge extent stating that the company has

created wealth for its owners, indicating that the company is doing financially very well.

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Measuring success of mergers and acquisitions

CONCLUSION

Measuring success of a merger of acquisition depends upon many factors like type of industry,

organizations’ cultures, National policies, human factors, valuation factors and so on. If the company

increases the shareholder value and achieve the motivations or objectives behind the merger or

acquisition, it would consider a success. The case, Tata – Chorus, analysis shows an unsuccessful

merger. But it is very early to say that it is an unsuccessful merger as the acquisition took place very

recently. As Tata acquired Corus for a whopping sum of approximately $12bn, there might be a

factor of Hubris involved in this. As the comparison between pre-, merger and post- merger period

shows a decrease in the shareholder value. So at this particular point of time it could be consider as

an unsuccessful acquisition.

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Measuring success of mergers and acquisitions

BIBLIOGRAPHY

Kamal Ghosh Ray;” Megers and Acquisitions-Strategy, value and integration”

Jennifer M. Vandeburg,Joan R. Fulton,Susan Hine,Kevin T. McNamara:”Driving forces and success

factors for mergers and acquisitions

Gurminder Kaur:”Corporate mergers and acquisitions”

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