strategic financial management chapter 13. mergers...

Strategic Financial Management

Chapter 13. Mergers, Acquisitions & Restructuring

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Types of Merger

• Horizontal – Companies of same industry are merged

• Vertical – Companies of different industry are merged

• Reverse – Large or profit making company merges with Small or

• Conglomerate – Companies with unrelated operations merge

• Congeneric – Merging companies are related through basic technologies, production processes or

markets

Mergers, Acquisitions & Restructuring

Amalgamation - When two entitiesmay be a new entity or either one

Merger - Two entitiescombine to dissolveexisting entities and giverise to a new entity.

Acquisitionacquiredsubsidiaryof ownership

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purely for revision purposes and will not help much in elaborating and understanding

If you have not downloaded these notes directly from our website then we urge you to do so as

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Companies of same industry are merged

Companies of different industry are merged

Large or profit making company merges with Small or loss making company

Companies with unrelated operations merge

Merging companies are related through basic technologies, production processes or

Mergers, Acquisitions & Restructuring

entities combine to form one entity (thisone of the combining entities).

Acquisition - One entity takes over another entity andentity either cease to exist or acts as a

subsidiary of the new parent company. There is a senseownership by acquirer in this case.

- Acquisition isconsent with theof the board

Hostile - Acquisition isdone without the consentof the board by acquiringmajority shares

Reconstruction /

Windingcompanyassetsnewapproved)

elaborating and understanding

you to do so as we

be a more updated version available on the

and practical purposes.

ntent, however if you find anything

loss making company

Merging companies are related through basic technologies, production processes or

Reconstruction / Arrangement / Reorganization

Winding up the existingcompany and transferringassets and liabilites to anew company (courtapproved)





Reasons and Rationale for M&A

• Synergies

o Operating – Similar operations in

o Economies of Scale – Large no. of units gives more bargaining power and lower average cost

o Economies of Scope – Complimentary activities of both companies can be used.

• Diversification – new areas of busi

• Taxation – losses adjustment

• Growth – Quickly grow by acquiring existing small businesses

• Consolidation of production capacities and increasing market power

acquiring all players in the same market

Gains from M&A

Transaction Costs – Legal Charges, Bank fees, Investment Banker fees

Combined Value – Value of acquirer, Stand alone value of target, Value of synergy = Combined Value

Principal steps in M&A

• Manage pre acquisition phase –

• Screen Candidates

• Eliminate not meeting criteria

• Negotiate

• Post-merger integration

Problems for M&A in India




Reasons and Rationale for M&A

Similar operations in both companies are combined has removes duplication

Large no. of units gives more bargaining power and lower average cost

Complimentary activities of both companies can be used.

new areas of business

Quickly grow by acquiring existing small businesses

Consolidation of production capacities and increasing market power – achieving monopoly by

acquiring all players in the same market

Legal Charges, Bank fees, Investment Banker fees

Value of acquirer, Stand alone value of target, Value of synergy = Combined Value

– maintain secrecy

both companies are combined has removes duplication

Large no. of units gives more bargaining power and lower average cost

Complimentary activities of both companies can be used.

achieving monopoly by

Value of acquirer, Stand alone value of target, Value of synergy = Combined Value





• Family owned corporates – majority shareholding by promoters

• SEBI rules and regulations

• Availability of funds for M&A

• Lack of exit policy

• Absence of efficient capital markets

Due diligence

Test the accuracy of company representations.

• Legal issues,

• Financial and Tax issues,

• Cross-border issues,

• Culture issues

Takeover Strategies

• Street Sweep –acquiring company

an open offer

• Bear hug – While acquirer threatens to make an open offer, the board of Target Company agrees to

a settlement.

The Acquisition Process

Five Essential Stages:

1. Competitive Analysis

2. Search and Screen

3. Strategy Development

4. Financial Evaluation

5. Negotiation

Target valuation for M&A

1. Earnings based valuation




majority shareholding by promoters

Absence of efficient capital markets

Test the accuracy of company representations. Focus areas:

acquiring company accumulates large no. of shares from open market before making

While acquirer threatens to make an open offer, the board of Target Company agrees to

accumulates large no. of shares from open market before making

While acquirer threatens to make an open offer, the board of Target Company agrees to





2. Market Based valuation

Reasons for Demerger/Divestment

1. To pay attention on core areas of business

2. Loss making units

3. Size of the firm may be too big to handle

4. Cash requirement

Discounted Cash Flow

•

•

•

•

•

Cost to create•

Capitalised Earning method

•

•

Market Capitalization

(listed)

Comparable multiples

(unlisted)




Reasons for Demerger/Divestment

To pay attention on core areas of business

the firm may be too big to handle

Determine Free Cash flow (Nopat + Dep. -working capital)

Discount the cash flows

Calculate TV (gordon grwoth - stable, growing;

Deduct debt

Final value - standalone value + synergy + loss if

Cost of building up the business from scratchconsideration with some margin over and above

Return on investments that is expected by anbusiness is estimated in the capitalized earningscapitalizing net profits of the business for currentof three years or projected years at required rate

Average Earnings / Required rate of return

• Market value of share x no. of shares

• Identify comparable firms

• Adjust for differences in size, market type etc

• Valuation is done on the basis of appropriatecompanrable firms. P/E, P/B are generally used

Capex - Changes in

multiple of BV, EBIT)

if compet. acuqires

scratch is taken in toabove that.

an investor. Value ofearnings method by

current year or averagerate of return.

etc.

appropriate multiples ofused.





Different ways of Divestment or Demerger

1. Sell off – Simple sale of a unit, assets etc. by one entity to another

2. Spin off – Part of the business is separated and created as a separate firm

3. Split up – Breaking up entire firm by series of spin offs and creating many entities out of a single

entity

4. Carve out – This is like spinoff, however some shares of new spun off company are sold in the

market by making public offer.

Corporate Controls

Ways to increase corporate control

• Going private – delisting

• Equity buyback – reducing the equity stake

• Buy outs – Management Buyouts




Different ways of Divestment or Demerger

Simple sale of a unit, assets etc. by one entity to another

Part of the business is separated and created as a separate firm

Breaking up entire firm by series of spin offs and creating many entities out of a single

This is like spinoff, however some shares of new spun off company are sold in the

market by making public offer.

ase corporate control

reducing the equity stake

Management Buyouts

Breaking up entire firm by series of spin offs and creating many entities out of a single

This is like spinoff, however some shares of new spun off company are sold in the





3. Asset based valuation: Considers either the book value or net adjusted value. Intangibles are value

separately and then added.

Net Adusted Asset value or Book value

•

Intangible Asset Valuation

•

•

Liquidation Value•




Considers either the book value or net adjusted value. Intangibles are value

• Value is calculated by adjusting the valueliablities to the fair market value

• Cost to create - cost to create and/or cost to replace

• Based on past or future economic benefits

• Capitalization of historic profits - applyinghistoric profits

• Gross profit differential method - valued onpremium a branded or patented product is able

• Excess profit method - Excess returs overbenchmark returns

• Relief from royalty - what the purchaser couldwould be willing to pay, for a license of similar

• Similar to book value, except that liquidationplace of market value

Considers either the book value or net adjusted value. Intangibles are value

of all assets &

replace

applying a multiple to

on the basis ofable to achieve

over and above

could afford, orsimilar assets.

value is used in





Type of questions asked in previous exams

1. EPS (accretive, decretive); calculate EPS after acquisition

2. Compare two methods of valuation and calculate range of payments

3. To find Exchange ratios given market prices

4. Find market price after merger

5. Separate value of debt and equity under different states of economy given the probabilities in each

economy

Unique Questions: Following questions are selected from previous examinations and cover all the

question types.




asked in previous exams

EPS (accretive, decretive); calculate EPS after acquisition

Compare two methods of valuation and calculate range of payments

To find Exchange ratios given market prices or earnings per share (nobody is at loss)

Separate value of debt and equity under different states of economy given the probabilities in each

ng questions are selected from previous examinations and cover all the

(nobody is at loss)

Separate value of debt and equity under different states of economy given the probabilities in each

ng questions are selected from previous examinations and cover all the





Question 1








Question 2








Question 3








Question 4








Question 5








Question 6








Question 7




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