Mergers and acquisitions (M&A) and corporate restructuring are a big part of the
corporate finance world. Every day, Wall Street investment bankers arrange M&A
transactions, which bring separate companies together to form larger ones. When they're
not creating big companies from smaller ones, they are doing the reverse by breaking up
companies through spin-offs, carve-outs or tracking stocks. Not surprisingly, these
actions often make the news. Deals can be worth hundreds of millions, or even billions,
of dollars. They can dictate the fortunes of the companies involved for years to come.
Broader Scope of Leveraged buyout
The Main Idea
One plus one makes three: this equation is the special alchemy of a merger or an
acquisition. The key principle behind buying a company is to create shareholder value
over and above that of the sum of the two companies. Two companies together are more
valuable than two separate companies - at least, that's the reasoning behind M&A.
Synergy is the magic force that allows for enhanced cost efficiencies of the new
business. Synergy takes the form of revenue enhancement and cost savings. By merging,
the companies hope to benefit from the following:
As every employee knows, mergers tend to mean job losses. Consider all the money
saved from reducing the number of staff members from accounting, marketing and other
departments. Job cuts will also include the former CEO, who typically leaves with a
Economies of scale
Whether it's purchasing stationery or a new corporate IT system, a bigger company
placing the orders can save more on costs. Mergers also translate into improved
purchasing power to buy equipment or office supplies - when placing larger orders,
companies have a greater ability to negotiate prices with their suppliers.
Acquiring new technology
To stay competitive, companies need to stay on top of technological developments
and their business applications. By buying a smaller company with unique technologies, a
large company can maintain or develop a competitive edge.
Improved market reach and industry visibility
Companies buy companies to reach new markets and grow revenues and earnings.
A merge may expand two companies' marketing and distribution, giving them new sales
opportunities. A merger can also improve a company's standing in the investment
community: bigger firms often have an easier time raising capital than smaller ones.
2. Varieties of Mergers
Here are a few types, distinguished by the relationship between the two companies
that are merging:
Two companies that are in direct competition and share the same product lines and
A customer and company or a supplier and company. Think of a cone supplier
merging with an ice cream maker.
Two companies that sell the same products in different markets.
Two companies selling different but related products in the same market.
Two companies that have no common business areas.
LBO is the generic term for the use of leverage to buy out a company. The buyer
can be the current management, the employees or a private equity firm known as
outsiders. Some leveraged buyouts occur in companies experiencing hard times and
potentially facing bankruptcy.
Common buy out Scenarios Positive and Negative Effects
Leveraged buyouts can have positive and negative effects, depending on which
side of the deal you are on. There are many scenarios driving a buyout, but four examples
are the repackaging plan, the split-up, the portfolio plan and the savior plan will be
discussed by us.
The Repackaging Plan
The repackaging plan usually involves a private equity company using leveraged
loans from the outside to take a currently public company private by buying all of its
outstanding stock. The buying firm's goal is to repackage the company and return it to the
marketplace in an initial public offering (IPO).
The acquiring firm holds the company for a few years to avoid the watchful eyes
of shareholders. This allows the acquiring company to repackage the company behind
closed doors, making adjustments here and there and dressing it up. Once the acquired
company is dressed up, it is offered back to the market as an IPO.
Those who stand to benefit from a deal like this are the original shareholders (if
the offer price is greater than the market price), the company's employees (if the deal
saves the company from failure), and the private equity firm that generates fees from the
3. day the buyout process starts and holds a portion of the stock until it goes public again.
Unfortunately, if no major changes are made to the company, it's a zero-sum game and
the new shareholders get the same financials the old company had.
The underlying premise in this plan is that the company, as it stands, is worth
more when broken up or with its parts valued separately. This is fairly common with
conglomerates that have acquired various businesses in relatively unrelated industries
over many years. The buyer is an outsider and may use aggressive tactics. If successful,
the company is dismantled after it is bought out and the parts are sold off to the highest
This method is the most feared by employees and management as they know their
jobs are just numbers on a page in this situation. These deals usually involve massive
layoffs as part of the restructuring process. There will ultimately be two sides of the
story, but the thought that any company could be taken out like this should inspire all
levels of management to keep their companies as healthy as possible.
The Portfolio Plan
The portfolio plan has the potential to benefit all participants, including the buyer,
the management and the employees. In a competitive marketplace, a company may use
leverage to acquire one of its competitors (or any company where it could achieve
synergies from the acquisition). The plan is risky: the company needs to make sure the
return on its invested capital exceeds its cost to acquire, or the plan can backfire. If
successful, all parties can benefit: the shareholders may receive a good price on their
stock, current management can be retained and the company may prosper in its new,
The Savior Plan
The savior plan is often drawn up with good intentions, but frequently arrives too late.
This scenario typically involves a plan involving management and employees to borrow
money to save a failing company. The term "employee owned" often comes to mind after
one of these deals goes through. While the concept is commendable, if the same
management and tactics stay in place, the likelihood of success is low. On the other hand,
if the company turns around after the buyout, everyone benefits.
Tracing back to history, merger and acquisitions have evolved in five stages and
each of these are discussed here. As seen from past experience mergers and acquisitions
are triggered by economic factors. The macroeconomic environment, which includes the
growth in GDP, interest rates and monetary policies.
First Wave Mergers
The first wave mergers commenced from 1897 to 1904. During this phase merger
occurred between companies, which enjoyed monopoly over their lines of production like
railroads, electricity etc. the first wave mergers that occurred during the aforesaid time
period were mostly horizontal mergers that took place between heavy manufacturing
4. End of 1st Wave Merger
Majority of the mergers that were conceived during the 1st phase ended in failure
since they could not achieve the desired efficiency. The failure was fuelled by the
slowdown of the economy in 1903 followed by the stock market crash of 1904. The legal
framework was not supportive either. The Supreme Court passed the mandate that the
anticompetitive mergers could be halted using the Sherman Act.
Second Wave Mergers
The second wave mergers that took place from 1916 to 1929 focused on the
mergers between oligopolies, rather than monopolies as in the previous phase. The
economic boom that followed the post World War I gave rise to these mergers.
Technological developments like the development of railroads and transportation by
motor vehicles provided the necessary infrastructure for such mergers or acquisitions to
take place. The government policy encouraged firms to work in unison. This policy was
implemented in the 1920s.
The 2nd wave mergers that took place were mainly horizontal or conglomerate in
nature. Te industries that went for merger during this phase were producers of primary
metals, food products, petroleum products, transportation equipments and chemicals. The
investments banks played a pivotal role in facilitating the mergers and acquisitions.
End of 2nd Wave Mergers
The 2nd wave mergers ended with the stock market crash in 1929 and the great
depression. The tax relief that was provided inspired mergers in the 1940s.
Third Wave Mergers
The mergers that took place during this period (1965-69) were mainly
conglomerate mergers. Mergers were inspired by high stock prices, interest rates and
strict enforcement of antitrust laws. The bidder firms in the 3rd wave merger were
smaller than the Target Firm. Mergers were financed from equities; the investment banks
no longer played an important role.
End of the 3rd Wave Merger
The 3rd wave merger ended with the plan of the Attorney General to split
conglomerates in 1968. It was also due to the poor performance of the conglomerates.
Some mergers in the 1970s have set precedence. The most prominent ones were the
INCO-ESB merger; United Technologies and OTIS Elevator Merger are the merger
between Colt Industries and Garlock Industries.
Fourth Wave Merger
The 4th wave merger that started from 1981 and ended by 1989 was characterized
by acquisition targets that wren much larger in size as compared to the 3rd wave mergers.
Mergers took place between the oil and gas industries, pharmaceutical industries, banking
and airline industries. Foreign takeovers became common with most of them being
5. hostile takeovers. The 4th Wave mergers ended with anti takeover laws, Financial
Institutions Reform and the Gulf War.
Fifth Wave Merger
The 5th Wave Merger (1992-2000) was inspired by globalization, stock market
boom and deregulation. The 5th Wave Merger took place mainly in the banking and
telecommunications industries. They were mostly equity financed rather than debt
financed. The mergers were driven long term rather than short term profit motives. The
5th Wave Merger ended with the burst in the stock market bubble.
Hence we may conclude that the evolution of mergers and acquisitions has been
long drawn. Many economic factors have contributed its development. There are several
other factors that have impeded their growth. As long as economic units of production
exist mergers and acquisitions would continue for an ever-expanding economy.
History in Pakistan
Pakistan and M&A
M&A activity has grown in Pakistan in the recent years. The Competition (Merger
Control) Regulations 2007 (the regulations) regulate the mergers and acquisitions in
Year Acquirer Acquired Merger or Acquisition
2008 NIB Bank ltd. PICIC Merger
2007 ABN AMRO Bank Ltd. Prime Bank Ltd. Acquisition
2007 LINK dot net WOL/DANCOM Acquisition
2007 Standard Charted Bank (Pak) Union Bank Ltd. Acquisition
2005 Itislat PTCL Acquisition
Year Acquirer Acquired Merger or Acquisition
2007 Pak Suzuki Motor Company Suzuki Motorcycle Acquisition
2008 Fatima Group/Arif Group Pakarab Fertilizer Acquisition
2005 Ibrahim Group Alfalah Bank Ltd. Acquisition
2008 Dalda Foods Wazir Ali Industries Acquisition
In Pakistan, banks have chosen to acquire / merge with other banks in order to
comply with the statutory requirement of raising their paid up capital to at-least Rs.6
billion by the end of 2009. Although, some of the banks have tackled the requirement of
capital adequacy by increasing their paid up capital, however M&A has become a
6. business reality in the country. This has involved merger of investments banks with their
mainstream banks as well as acquisition of smaller banks by the larger banks. The
privatization policy of the government has resulted in acquisitions of ABL, UBL and
Ratio Analysis of RBS
2004 2005 2006 2007
£(000) £(000) £(000) £(000)
Assets 588,122 776,827 871,432 1,840,830
- - - -
Equity 33,905 35,435 40,227 53,038
- - - -
Debt 39,242 126,077 147,219 310,095
- - - -
Current Assets 536,117 720,743 812,468 1,654,533
- - - -
Current Liabilities 474,541 646,324 727,094 1,575,089
- - - -
Fixed Assets 52,005 56,084 58,964 186,318
- - - -
C.A- Inventory 4,409,915 4,783,035 5,674,074 4,005,769
- - - -
No. of Shares 92,135 120,744 131,438 157,303
- - - -
Sales(Interest Income) 16,632 21,331 24,688 32,252
COGS 6,505,262 10,572,634 11,212,111 14,531,477
- - - -
int.exp) 9,071 9,918 10,596 12,069
- - - -
Net Income 5,289 5,558 6,497 7,788
- - - -
Total Liability 554,217 741,392 831,205 1,787,791
Years 2004 2005 2006 2007
7. Liquidity Ratio
Current Ratio 1.13 1.12 1.12 1.05
Debt to Equity 115.74% 355.80% 365.97% 584.67%
Debt Ratio 94.24% 95.44% 95.38% 97.12%
Common Equity Ratio 5.76% 4.56% 4.62% 2.88%
C.L to Equity 14.00 18.24 18.07 29.70
Net Profit Margin 31.8% 26.1% 26.3% 24.1%
Gross Profit Margin 54.5% 46.5% 42.9% 37.4%
Return on Asset 0.9% 0.7% 0.7% 0.4%
Return on Equity 15.6% 15.7% 16.2% 14.7%
EPS - - 0.54 0.64
Asset Turnover 0.03 0.03 0.03 0.02
Fixed Asset Turnover 3.13 2.63 2.39 5.78
Net Total Solvency
Income Deprecation liabilities Ratio
2004 5289.00 1674.00 554217.00 1.26%
2005 5558.00 1825.00 741392.00 1.00%
2006 6497.00 1678.00 831205.00 0.98%
2007 7788.00 1932.00 1787791.00 0.54%
2008 (38344.00) 3154.00 2342773.00 -1.50%
8. Circumstances/Reasons for Acquisition of ABN Amro
ABN AMRO had come to a crossroads in the beginning of 2007. The bank had
still not come close to its own target of having an ROE that would put it among the top 5
of its peer group, a target that the CEO had set upon his appointment in 2000. From 2000
until 2006, ABN AMRO's stock price stagnated.
Financial results in 2006 added to concerns about the bank's future. Operating expenses
increased at a greater rate than operating revenue, and the efficiency ratio deteriorated
further to 69.9%. Non-performing loans increased considerably year on year by 192%.
Net profits were only boosted by sustained asset sales.
ABN AMRO Financial Data
Years 2002 2003 2004 2005 2006
Sales net of interest €18.280mn €18.793mn €19.793mn €23.215mn €27.641mn
EBITDA €4.719mn €5.848mn €6.104mn €6.705mn €6.360mn
Net Result Share of the group €2.267mn €3.161mn €4.109mn €4.443mn €4.780mn
Staff 105,000 105,439 105,918 98,080 135,378
On February 2007, the call came from the TCI hedge fund which asked the
Chairman of the Supervisory Board to actively investigate a merger, acquisition or
breakup of ABN AMRO, stating that the current stock price didn't reflect the true value
of the underlying assets. TCI asked the chairman to put their request on the agenda of the
annual shareholders' meeting of April 2007.
Events accelerated when on March 20 the British bank Barclays and ABN AMRO
both confirmed they were in exclusive talks about a possible merger. On March 28, ABN
AMRO published the agenda for the shareholders' meeting of 2007.
However, in April, another British bank, the Royal Bank of Scotland (RBS)
contacted ABN AMRO to propose a deal in which a consortium of banks, including RBS,
Belgium's Fortis, and Spain's Banco Santander would jointly bid for ABN AMRO and
thereafter break up the different divisions of the company between them. According to
the proposed deal, RBS would take over ABN's Chicago operations, LaSalle, and ABN's
wholesale operations while Banco Santander would take the Brazilian and Italian
operations and Fortis, the Dutch operations.
On April 23 ABN AMRO and Barclays announced the proposed acquisition of
ABN AMRO by Barclays. The deal was valued at €67 billion. Part of the deal was the
sale of LaSalle Bank to Bank of America for €21 billion.
After that the RBS-led consortium brought out their indicative offer, worth €72
billion, if ABN AMRO would abandon its sale of LaSalle Bank to Bank of America.
During the shareholders' meeting the next day, a majority of about 68% of the
shareholders voted in favor of the breakup as requested by TCI. Bank of America
absorbed LaSalle effective October 1, 2007.
On July 23 Barclays raised its offer for ABN AMRO to €67.5bn, after securing
investments from the governments of China and Singapore, but it was still short of the
RBS consortium's offer. Barclay's revised bid was worth €35.73 a share — 4.3% more
9. than its previous offer. The offer, which included 37% cash, remained below the €38.40-
a-share offer made the week before by the RFS consortium. Their revised offer didn't
include an offer for La Salle bank, since ABN AMRO could proceed with the sale of that
subsidiary to Bank of America. RBS would now settle for ABN's investment-banking
division and it’s Asian Network.
On July 30 ABN AMRO withdrew its support for Barclays’ offer which was
lower than the offer from the group led by RBS. While the Barclays offer matched ABN
AMRO’s “strategic vision,” the board couldn’t recommend it from “a financial point of
view.” The US$98.3bn bid from RBS, Fortis and Banco Santander was 9.8% higher than
Barclays Bank withdrew its bid for ABN AMRO in October, clearing the way for
the RBS-led consortium's bid to go through
On October 9, the RFS consortium led by Royal Bank of Scotland, bidding for
control of ABN AMRO, formally declared victory after shareholders, representing 86%
of the ABN AMRO’s shares, accepted the RFS group’s €72bn offer.
Sources of Financing used for Acquisition of ABN Amro
Forecasts for Acquisition
RBS believed that this transaction would provide enhanced growth prospects and
attractive financial returns. As a result of the transaction, RBS expected to deliver cost
savings amounting to €1,237 million and net revenue benefits amounting to €481 million,
by the end of 2010.
The internal rate of return on the acquisition of the ABN AMRO Businesses was
15.5% post-tax, well above the Group’s hurdle rate of 12% post-tax. The acquisition was
expected to deliver a after tax return on investment of 13.2% in 2010, and to increase
Group adjusted earnings per share by 2.0% in 2009 and by 7.0`% in 2010 (which actually
turned out to be negative 1.69).
The acquisition of ABN AMRO gave RBS the ability to accelerate their existing
strategies and growth outside the UK, particularly in rapidly expanding markets and
increasing customer franchises. The integration would create synergies which were
expected to total €2.3 billion, compared with the original estimate of €1.7 billion.
Sources of Financing
The offer, given by RBS Group of €71 billion included 37% cash, which would
give €38.40-a-share to ABN share holders. RBS would acquire the investment banking
business, commercial clients, the Asian units and any thing that was left of the LaSalle
Bank (which was sold to Bank of America for 23billion) for a consideration of €27
billion. This was financed by Tier 1 capital.
RBS’s Tier 1 capital ratio at 31 December 2007 was 7.3% and our total capital
ratio 11.2%, which decreased considerably as compared to Tier 1 ratio 7.5% and Total
capital ratio 11.5% of 2006. At the time of the bid for ABN AMRO RBS indicated their
intention to rebuild their capital ratios. RBS thought that the improved financial returns
10. expected from the acquisition would help to accelerate rehabilitation of the Group’s
Santander acquired the Italian and Brazilian units of ABN for a consideration of
€20 billion (Santander sold the Italian units to the Italian bank, Monte Dei Paschi Di
Siena, for €9 billion). Fortis acquired the Dutch divisions by paying €24 billion. The bank
tapped shareholders for €13.4 billion (issued right shares) to pay for its €24 billion
portion. This financing of €38-a-share offer, which included €35.60 in cash, to finance
the purchase Fortis issued right shares, available to the existing shareholders at a
discount, €15 per share. However, by June 2008, Fortis announced that an international
financial crisis was coming and that it needed to fortify its capital by raising an additional
€ 8.3 billion. An extra 200 million shares were issued at €10.
RBS had debt equity ratio of 365.97% in 2006 which was higher then industry
average of 276.03%. In 2007 and 2008 the ratio increases to 584.67% and 1733.24%
respectively. Due to this high Debt equity ratio RBS financed the acquisition with equity.
Wall Street Journal
Investment Dealer’s Digest
Annual Reports of RBS 2006, 2007, 2008
Annual Reports of ABN AMRO 2006, 2007
Corporate Finance by Ross, Westersfield
Principles of Corporate Finance by Brealey, Myers
Fundamental of Financial Management by Eugene F Brighum, Houston