mergers and acquisitions overview
TRANSCRIPT
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Mergers and Acquisitions
Overview M&A market trends
Why acquire?
Key conceptsMarket-extension merger
Two companies that sell the same products in different
markets.
Product-extension merger
Two companies selling different but related products in the
same market.
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Why?
Gain market share
Economies of scale
Enter new markets Acquire technology
Utilization of surplus funds
Managerial Effectiveness
Strategic Objective
Vertical integration
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1) Increased Market Power: It is intended to reduce the competitive balance of the industry.
2) Revamping production facilities: To achieve economies of scale by amalgamating production
facilities through more intensive utilization of plant and resources.
3) Financial strength: To improve liquidity and have direct access to cash resource.
4) General gains: To improve its own image and to offer better satisfaction to
consumers or users of the product.
5) Procurement of supplies: To obtain economies of purchase in the form of discount, savings in
transportation costs, overhead costs in buying department, etc.
Reasons for Mergers & Acquisitions
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Conclusion
What works for the company is announced
with much fanfare, but what remainshidden is that what does not work!!!
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1) Integration Facilities: Different Financial & Control Systems can make integration of
firms difficult.
2) Large or Extraordinary Debt:
Costly Debt can create onerous burden on cash outflows.
3) Inadequate Evaluation of Target: Inadequate Evaluation causes acquirer to overpay for the firm.
4) Inability to achieve synergy: Justifying Acquisitions can increase estimate of expected benefits.
5) Overly Diversified: Acquirer doesnt have expertise required to manage unrelated
businesses
Why Mergers & Acquisitions Fail?
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Key Drivers of a Successful
Acquisition
What creates value in an acquisition?
Why do some acquisitions fail? Academic research
Can firms learn to acquire?
Synergy
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Attractiveness of Target
Companies
Structure
Asset Purchase
Business Purchase
Share Purchase
A Mixture
Apportionment of Risk
No Hidden matters Remedy warranty
Indemnity
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Process of Acquisition
Finding A Target Business
Appointing Advisers
Negotiating terms
Due Diligence
Exchange of Contracts Completion
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Culture
M&AStrategy
Resources
Business
Objective
Structure
Leadership
Person
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Taxation and Accountancy
Considerations
Tension between Acquisition / sale of shares
or assets.
Due Diligence
Tricky areas
Accounting issues
Accounting policies of the Target
Accounting for Goodwill
Fair value accounting
Earnings per share
Other Matters
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Negotiating Terms
The nature of the fit
Commonality of client base
Financial strength Strategic intent
Sharing of resources
Applicable Benefits
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Appointing Advisers
The Right Chemistry
The Right Experience
Size is not Everything Talk Your Language
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Finding A Target Business
Synergy of Operations
Help the Organizations to Achieve
Strategic Objectives Enter new markets
Vertical Integration
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Acquisition Structure
Asset purchase
Share purchase
Merger
Hostile
Acquisition accounting fundamentals
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Documentation and Agreements
Confidentiality agreement
Letter of intent Stock purchase agreement
Asset purchase agreement
Fairness opinion
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Sequence of Events
Initial negotiations to closing
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How Does the Integration
Process Affect Value Creation?
Pre merger planning
Post merger planning
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Managing for Value Creation
Key managerial success factors
Merger planning - start at the top
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Valuation
Appraisal Principles
Valuation Methods
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Taxation and Accountancy
Considerations
Tension between Acquisition / sale of shares
or assets.
Due Diligence
Tricky areas
Accounting issues
Accounting policies of the Target
Accounting for Goodwill
Fair value accounting
Earnings per share
Other Matters
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Financing the Acquisition
Financing mix
Consideration
Methods of payment
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VALUATION OF FIRMS INMERGERS AND ACQUISITIONS
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Motives and Determinants of Mergers
Synergy Effect
- Operating Synergy
- Financial Synergy
Diversification
Economic Motives- Horizontal Integration
- Vertical Integration
- Tax Motives
NAV= Vab (Va+Vb) P E
Where Vab = combined value of the 2 firms
Vb = market value of the shares of firm B.
Va = As measure of its own value
P = premium paid for B
E = expenses of the operation
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-2
Dividend Discount Models
31 2
0 2 3 .......1 (1 ) (1 )
DD D
V k k k!
Where Vo = value of the firm
Di = dividend in year I
k = discount rate
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-3
The Constant Growth DDM
2
0 0
0 2
(1 ) (1 )......
1 (1 )
D g D g V
k k
!
And this equation can be simplified to:
0 10
(1 )D g DV
k g k g
! !
where g = growth rate of dividends.
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-4
Price-Earnings Ratio
0
1
11
/
P PVGO
E k E k
!
-
where PVGO = Present Value of Growth Opportunity
0 1
1
(1 )P E b
E k ROExb
!
Implying P/E ratio
0
1
1P b
E k ROExb
!
where ROE = Return On Equity
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-5
Cash Flow Valuation Models
- The Entity DCF Model : The entity DCF model values the value of a company asthe value of a companys operations less the value of debt and other investor claims,
such as preferred stock, that are superior to common equity. Value of Operations: The value of operations equals the discounted value of expected
future free cash flow.
. Value of Debt
. Value of Equity
Net Operating Profit - Adjusted TaxesContinuing Value =
WACC
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-6
What Drives Cash Flow and Value?
- Fundamentally to increase its value a company must doone or more of the following:
. Increase the level of profits it earns on its existing capitalin place (earn a higher return on invested capital).
. Increase the return on new capital investment.
. Increase its growth rate but only as long as the return onnew capital exceeds WACC.
. Reduce its cost of capital.
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FIRM VALUATION IN MERGERS AND
ACQUISITIONS-7
The Economic Profit Model: The value of a companyequals the amount of capital invested plus a premium equal to the
present value of the value created each year going forward.
Pr ( ) Economic ofit Invested Capital x ROIC WACC! where ROIC = Return on Invested Capital
WACC = Weighted Average Cost of Capital
Pr ( ) Economic ofit NOPL AT Invested Capital x WACC!
where NOPLAT = Net Operating Profit Less Adjusted Taxes
Value=Invested Capital+Present Value of Projected Economic Profit
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STEPS IN VALUATION
Analyzing Historical Performance
NOPLATReturn on Investment Capital =Invested Capital
FCF = Gross Cash Flow Gross Inves tments
Economic Profit = NOPLAT (Invested Capital x WACC)
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STEPS IN VALUATION-2
Forecast Performance- Evaluate the companys strategic position, companys
competitive advantages and disadvantages in theindustry. This will help to understand the growth potentialand ability to earn returns over WACC.
- Develop performance scenarios for the company and theindustry and critical events that are likely to impact theperformance.
- Forecast income statement and balance sheet line itemsbased on the scenarios.
- Check the forecast for reasonableness.
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STEPS IN VALUATION-3
Estimating The Cost Of Capital
- Develop Target Market Value Weights
- Estimate The Cost of Non-equity Financing
- Estimate The Cost Of Equity Financing
(1- )b c p s
B P SWACC k T k k
V V V!
where
kb = the pretax market expected yield to maturity on non-callable, non convertible debt
Tc = the marginal taxe rate for the entity being valuedB = the market value of interest-bearing debt
kp = the after-tax cost of capital for preferred stock
P = market value of the preferred stock
ks = the market determined opportunity cost of equity capital
S = the market value of equity
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STEPS IN VALUATION-4
Estimating The Cost Of Equity Financing
- CAPM
. Determining the Risk-free Rate (10-year bond rate)
. Determining The Market Risk premium 5 to 6 percent rate is used for the UScompanies
. Estimating The Beta
( ) s f m f
k r E r r F ! -
where rf = the risk-free rate of return
E(rm) = the expected rate of return on the overall market portfolio
E(rm)- rf = market risk premium
= the systematic risk of equity
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STEPS IN VALUATION-5
The Arbitrage Pricing Model (APM)
1 1 2 2( ) ( ) ....
s f f f k r E F r E F r F F ! - -
where E(Fk) = the expected rate of return on a portfolio that mimics the kth factor and is
independent of all others.
Beta k = the sentivity of the stock return to the kth factor.
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STEPS IN VALUATION-6
Estimating The Continuing Value- Selecting an Appropriate Technique
. Long explicit forecast approach
. Growing free cash flow perpetuity formula
. Economic profit technique
T+1 T+1Economic Profit (NOPLAT )( / )( )
CV = +( )
g ROIC ROIC WACC
WACC WACC WACC g
where
Economic Profit T+1
= the normalized economic profit in the first year after the explicitforecast period.
NOPLAT T+1 = the normalized NOPLAT in the first year after the explicit forecast period.
g = the expected growth rate of return in NOPLAT in perpetuity
ROIC = the expected rate of return on net new investment.
WACC = weighted average cost of capital
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STEPS IN VALUATION-7
Calculating and Interpreting Results
- Calculating And Testing The Results
- Interpreting The Results Within TheDecision Context
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Anti-takeover Mechanisms
Poison pills and other defensive measures
Anti-trust Policies
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I believe this will be the first step in
showing that Indian industry can stepoutside the shores of India in an
international market place and acquit
itself as a global player
- Ratan Tata
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