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mergers and acquisition

  1. 1. A Project Report on Mergers and Acquisitions Date: 11th , August 2008 Project Guide: Mr. Shinde Submitted By: Mr. Sunil Shendage
  2. 2. ACKNOWLEDGEMENT I wish to take this opportunity to express my heart-felt gratitude to Mr. for helping me at every stage of the project. I also wish to thank the Director for his encouragement throughout the completion of this project. Thanking You, Sunil Shendage
  3. 3. OBJECTIVE Theoretically it is assumed that Mergers and Amalgamations improve the performance of the company. Because of Synergy effect, increased market power, Operational economy, Financial Economy, Economy of Scales etc. But does it really improve the performance in short run as well as long run. Various studies have already been done on this matter.
  4. 4. Table of Contents - Introduction...............................................................................................................1 Scope for Mergers......................................................................................................2 Meaning of Mergers &Acquisitions...........................................................................2 Types of Mergers &Acquisitions................................................................................3 Objectives of Mergers &Acquisitions.......................................................................4 Trends in Mergers &Acquisitions.............................................................................9 The Acquisition Process..........................................................................................13 Mergers &Acquisitions in MNEs.............................................................................18 Forms of Corporate Downsizing...............................................................................21 Legal Procedure........................................................................................................22 Indian Scenario.........................................................................................................28 Mergers &Acquisitions in IT Sector..........................................................................31 Patterns in MNE and Mergers &Acquisitions............................................................35 Recent Major Mergers &Acquisitions in I T Industry ...............................................36 Merger Control...........................................................................................................41 Risk in Mergers &Acquisitions....................................................................................42 The Contours of M&A in Telecom ………………………………….. 43 Case- TATA Tea and Tetley.......................................................................................67 Making Mergers smoothers........................................................................................68 Measuring PMI.............................................................................................................81
  5. 5. Findings..........................................................................................................................82 Conclusion.......................................................................................................................85
  6. 6. PREFACE Mergers and acquisitions are increasingly getting popular and efficient way for corporate growth. Yet their success cannot be assured. A majority of mergers and acquisitions fall short of their stated goals. While researchers try to explain some failure from financial and strategic standpoints, a considerable number of mergers and acquisitions have not explored the organizational and human resource related issues. THE year 2005 has been referred as the year of mergers and acquisitions (M&A). In India, M&A deals in excess of $13 billion were struck in 2005 compared to $4.5 billion in 2004. In Asia, India stands next only to China in M&A activity. There were 163 inbound acquisitions in India valued at $2.83 billion. The terms 'mergers', "acquisitions' and "takeovers' are often used interchangeably. However, there are differences. While merger means unification of two entities into one, acquisition involves one entity buying out another and absorbing the same. There are several advantages in Mergers and acquisitions — cost cutting, efficient use of resources, acquisition of competence or capability, tax advantage and avoidance of competition are a few. While takeovers are regulated by SEBI, M&A falls under the Companies Act. In cross-border transactions, international tax considerations also arise. US economy is trying to keep check number of mergers and acquisitions in Trans-national companies in the year 2006.
  7. 7. Report on Mergers and Acquisitions Mergers and Acquisitions: Introduction 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, corporate finance deals do the reverse and break 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. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time. Next time you flip open the newspaper's business section, odds are good that at least one headline will announce some kind of M&A transaction. With economic globalization, companies are growing by merger and acquisition in a bid to expand operations and remain competitive. The complexity of such transactions makes it difficult to assess all risk exposures and liabilities and requires the skills of a specialist advisor. Generally the approach followed by the companies is as follows: • Pre-Acquisition Due Diligence Identification of hidden and potential liabilities, unreserved claims, and cash-flow implications, as well as major gaps in the target company's current insurance and employee benefits programs including pension fund valuation and transfer • Integration Assistance with the identification of the skills and resources needed to ensure a smooth integration • Pre-Closing Design of post-completion insurance and benefits programs before the transaction date to take advantage of enhanced coverage and competitive pricing
  8. 8. Report on Mergers and Acquisitions • Post-Closing Ensuring the recommendations highlighted in the due diligence reports are implemented India is the second largest and fastest growing mobile telecom market in the world many international players are waiting to gain entry into this attractive market which license for 3G service are expected to be auction out later during 2008 India also has very low telecom penetration close to 15%-compared to other emerging market like china and developed countries like the USE where telecom penetration range from 20%to 60%given the attractive market that it is we have seen global major like Vodafone recently gaining in to it by paying very high premium domestic India mobile telecom operators are also trying to consolidate their positions and thereby grow to become strong players who can capture a largest pie in the untapped mobile telecom market the current transaction between idea cellular and spice telecom was also finalized with the same objective of consolidation and growth in the attractive India mobile telecom market Scope for Mergers The scope of merger is generally downgraded when cultures of two organizations are found to be incompatible. Although it is not possible to separate out natural culture from
  9. 9. organizational climate (culture), it has to be managed through engineering the norms of the work place in the interest of strategy and the commercial imperative. Cross- cultural comparisons can give real role model firms whose practices can be observed and aspired. Managing national culture in two autonomous organizations after a global merger is largely an issue relating to personnel management, which can be handled by selecting key boundary positions that can mentally budge the differences and build cohesive teams around them. Otherwise, in case of two different firms merging structurally have to design new systems and practices, which are acceptable to both sides, i.e., within parameters legitimated by two different national cultures. To reinforce cultural change, leadership and communication are essential and it has to start essentially from the top. Human resources practices if focused towards integration and acquisition goals can immensely contribute to cultural change. These core practices are of selection, appraisal, reward and development. These human resources practices can bring two cultures closer and together. There is such a diversity of national difference in each of the global deals that there can be no general presumption to ensure success of the deals. In short, the common problem among the M&A failures is neglect of human factor but the solution varies across the countries depending upon cultural, political and economic variability. Meaning of Mergers and Acquisitions Mergers and acquisitions take the form of open offers, substantial sale of equity, sale of distressed assets by financial intermediaries, schemes of arrangement by companies, etc. There is also a rising trend in buyback of issued equity by companies. Disinvestments are also acquisitions by the new owners of the business hitherto owned by the government. This trend is as significant at the State level (if not more) compared to the Central
  10. 10. government. Report on Mergers and Acquisitions The phrase mergers and acquisitions or M&A refers to the aspect of corporate finance strategy and management dealing with the merging and acquiring of different companies as well as other assets. Usually mergers occur in a friendly setting where executives from the respective companies participate in a due diligence process to ensure a successful combination of all parts. On other occasions, acquisitions can happen through a hostile takeover by purchasing the majority of outstanding shares of a company in the open market. In the United States, business laws vary from state to state whereby some companies have limited protection against hostile takeovers. One form of protection against a hostile takeover is the shareholder rights plan, otherwise known as the "poison pill". Historically, mergers have often failed to add significantly to the value of the acquiring firm's shares. Corporate mergers may be aimed at reducing market competition, cutting costs (for example, laying off employees), reducing taxes, removing management, "empire building" by the acquiring managers, or other purposes which may not be consistent with public policy or public welfare. Thus they can be heavily regulated, requiring, for example, approval in the US by both the Federal Trade Commission and the Department of Justice. Types of M& As Vertical Combination A vertical combination is one in which a company takes over or seeks a merger with another company in order to ensure backward integration or assimilation of the sources of supply or forward integration towards market outlets. The acquirer company gains a strong position due to the imperfect market of its intermediary products and also through control over product specifications. However, these gains must be weighed against the adverse effects of the merger. For instance, firms which have monopoly power in one stage may increase barriers to entry through vertical integration and this would help to discriminate between different purchasers by monopolisation of raw material supplies or distributive outlets.
  11. 11. Report on Mergers and Acquisitions Horizontal Combination A horizontal combination is a merger of two competing firms belonging to the same industry which are at the same stage of the industrial process. These mergers are carried out to obtain economies of scale in production by eliminating duplication of facilities and operations and broadening the product line, reducing investment in working capital, eliminating competition through product concentration, reducing advertising costs, increasing market segments and exercising better control over the market. It is also an indirect route to achieving technical economies of large scale. Circular Combination In a circular combination, companies producing distinct products in the same industry, seek amalgamation to share common distribution and research facilities in order to obtain economies by eliminating costs of duplication and promoting market enlargement. The acquiring company obtains benefits in the form of economies of resource sharing and diversification (An off and Weston, 1962). Conglomerate Combination A conglomerate combination is the amalgamation of two companies engaged in unrelated industries. It enhances the overall stability of the acquirer company and improves the balance in the company's total portfolio of diverse products and production processes. Through this process, the acquired firm gets access to the existing productive resources of the conglomerate which result in technical efficiency and furthermore it can have access to the greater financial strength of the present acquirer which provides a financial basis for further expansion by acquiring potential competitors. These processes also lead to changes in the structure and behavior of acquired industries since it opens up new possibilities (Mueller, 1969). Objectives of M&A Corporate India is re-shaping itself from conglomerate structure to focused organizations in order to be core competent. M&A has become a powerful tool to accomplish this objective. The year 2005 (up to November) has witnessed unprecedented growth in Indian M&A market crossing $13 billion with over 245 deals against $9.5 billion with 237 deals during 2004. Smart sizing of the balance sheets has become absolutely necessary for sustainable growth. Restructuring in any form, be it organizational or product-market portfolio, cannot be efficiently handled without
  12. 12. resorting to financial restructuring of the organization. Takeovers and corporate control are also taking place at the same pace. Today, corporate managers have to understand the strategy towards the M&A, divestment, spin-off, takeover and corporate control, etc. This program is aimed at imparting conceptual framework and related strategies for corporate restructuring and how it is affected through the tool of M & A in order to sustain competitive advantage. Mergers, Acquisitions and Alliances (MAA) are century old phenomena for corporate survival or death. In the United States, the wave of mergers emerged in the beginning of the 20th century, which were characterised by wider diversification leading to formation of conglomerates. But the Great Depression of 1929 aborted this wave abruptly. During 1960's, the subsequent waves strengthened stability of M & A due to long lasting recovery of the world economy. The current M & A wave has begun in the early 1990's in the wake of globalization and liberalization of foreign investment norms by a large number of countries, leading to phenomenal rise in cross-border acquisitions. Today, there exists clearly a market for M & A and corporate control. The total value of global M & A is more than 3.5 trillion dollar and the US market accounts for almost half of it. Business Combinations Reasons for Business Combinations: Some of the common for business combinations are: 1. Growth: One of the fundamental motives that drives Mergers and Acquisitions is the growth impulse of firms. Firms that desire to expand have to choose between two generic growth strategies: organic growth or acquisitions driven growth. Organic growth is a slow steady process and very often a function of time factor. Acquisition led growth is an aggressive strategy and is relatively riskier to an organic growth strategy. For example; in an industry, which is having overcapacity, a firm which intends to expand may necessarily have to choose acquisition driven strategy. This is because organic growth would entail creation of additional capacity and may prove suicidal by adding to the existing overcapacity. Secondly, in a situation where speed is a essence to capitalize on opportunity, organic growth may be an inappropriate strategy. 2. Synergy: The concept of synergy is based on the principal that the whole is greater than sum of the parts. Simply stated, synergy is the phenomena where 2+2 5.In the context of merger, this translates into the ability of business combination to be more profitable than the sum of the profits of the individual firms that were combined. The synergy may be in the form of revenue enhancement and Cost reduction. Clement and green span define revenue-enhancing synergy as "a newly created or strengthened product or service that is formulated by the fusion of two distinct attributes of the merger partners and which generate immediate and/or long -term
  13. 13. revenue growth". Revenue enhancement synergies vary from transactions to transactions. For example, this is the basis in the Merger between Citibank and Travelers group. Citibank is one of the worlds leading bank in the area of Corporate Banking and Retail Banking. Travelers Group operate in the area of insurance, retail financial services and Investment banking. It was expected that there would be great potential for revenue enhancement by Cross-selling of the products to each others clients. The biggest problem with the revenue enhancement synergy is the difficulty in qualifying its benefits. Cost reducing synergies refer to the potential to reduce the cost of operations. This is possible in case the merging firms having overlapping operations. One of the major factors which are resulting in the spate of mergers in the banking industry is the potential to cut costs. The merged bank is able to close branches in case both the banks have branches in same area. It is observed that banks mergers are accompanied by announcements of Lay-offs of staff. The cost reduction may arise due to economies of Scale and /or economies of scope. Economies of scale refer to the benefits arising out of increase in the size of operations. For example: better power with suppliers to reduce the cost of raw materials. Economies of Scope arise due to the ability of the firm to use one set of input to provide a broader range of products and services. In the case of bank merger cited above, the may have a common platform for similar operations like a single dealing rooms earlier, a single risk management department, a single HR function, a single legal department, etc. 3. Managerial Efficiency: Some acquisitions are motivated by the belief that the acquirer management can better manage the targets resources. This hypothesis is based on the assumption that the two firms have different levels of managerial competence. The acquirers management competence is superior to its target's. Hence the value of the target firm will rise under the management control of the acquirer. This is one of the premises on which the acquirer is willing to pay a premium to assume control of the target firm. 4. Market Entry: Firms often use acquisition as a strategy to enter into new markets or a new territory. This gives them a ready platform on which they can future build their operations. For Example, Whirpool acquired a controlling stake of 51% in Kelvinator India to enter into Indian Markets. Similarly Warburg, a leading European investment bank acquired Dillon Read an American brokerage house to gain entry into the lucrative American Markets. 5. Diversification: Firms indulge in diversification to overcome concentrating risks. Firms which are excessively dependent on a single product are exposed to the risk of the market for that product. Diversification reduces such risks. For Example, Investment Banking firms are exposed to the vagaries of the stock markets and have highly volatile earning stream. Asset Management firms have relatively stable stream of earnings and have close relationships with the
  14. 14. investment banks. Hence several investment banks acquired asset management firms to reduce volatility of the earnings stream. However diversification into unrelated products in which the firm has no competitive advantage should be avoided. 6. Tax Shields: Tax shields play an important role particularly in acquisition of distressed firms. Firms in distress have accumulating past losses and unclaimed depreciation benefits on their books. A profit making, tax paying firm can derive benefits from these tax shields. They can reduce or eliminate their tax liability by benefiting from a merger from these firms. In some countries including India, tax laws do not permit passing of such tax shields to the acquiring firm expect under specific circumstances. This has led to an innovative practice called as Reverse Merger. A reverse entails merging of a healthy firm into a sick, unit so that the tax shields are not lost. 7. Strategic: The reason for acquisition can be strategic in nature. The strategic factors would change from deal to deal. The two firms may be in complementary business interests and a merger may results in consolidating their position in the market. For example, American On-Line (AOL) is in the business of providing Internet access and is world's largest access provider. Time Warner is a major media firm with wide business interests including print media, broadcasting, music, etc In early 2000 AOL acquired Time Warner to ensure availability of Content for websites and portals. This combination of access and content is assumed. To be a winning combination which will dominate the Internet world. Another strategic reason can be to pre-empt a competitor from acquiring a particular firm. For example, Gujarat Abuja Cements is reported to have acquired the Tate’s stake in ACC to prevent Lafarge from acquiring it. Lafarge’s acquisition of ACC would have posed a major threat to Gujarat Ambuja's plan to emerge as a leader in the cement industry. In addition these reasons there are some of the unstated reasons for acquisitions are: 1..Megalomania: Megalomania refers to being excessively self-obsessed and arises from a high level of over confidence. Some managers have an aura about their own managerial competence and believe that they deserve to preside their own managerial competence over large corporate empires. They tend to acquire firms to satisfy their own ego. Very often, the benefits of such acquisitions are only illusory and end up in failures. 2.Hubris Spirit: Hubris spirit refers to the animal spirit, which leads to paying an excessive price to make an acquisition. This is particularly evident in case of competitive tender offer to acquire a target. The parties involved in the contest may revise the price upwards time and again. The urge to win the game often results in the winner curse. The winners refer to the ironic hypothesis that states that firms which overestimates, the value of the target, most wins the contest. The factors that
  15. 15. results in the hubris spirit are the desire to avoid a loss of face, media praise, urge to protect as an "aggressive firm, inexperience, overestimation of the synergies, overenthusiastic investment bankers, etc
  16. 16. Trends in M&As Four periods of economics history have witnessed very high levels of merger activity, which are called as merger waves. These periods were characterized by cyclical activities i.e. large number of mergers followed by relatively fewer mergers. The current period (since 1992) is called as the fifth wave. In the first three waves merger activity was concentrated in the United States of America. The fourth and the fifth waves were global in nature though the impact of the waves is most pronounced in USA. First Wave: The first merger wave occurred after the Depression of 1883.It peaked between 1898 and 1902 though it began in 1987 and ended in 1904.The merger had the greatest impact of 8 specific industries viz, primary metals, bituminous coal, food products, chemicals, machinery, transportation, equipments, petroleum and fabricated metal products. These industries accounted for almost two-thirds of the total mergers during this period. The mergers in the first wave were predominantly horizontal combinations. These resulting giant captured 75% of the steel market of the United States. Similarly Standard Oil owned by Jhon D Rockfeller commanded 85% of the market share. Another feature of this wave was creation of "trusts", where the owners of the competing companies put their stock in the voting trusts and agreed not to compete against each other. In a typical trusts, equity holders of the competing firms (in some cases as many as 200 competitors) placed the voting rights of there shares in the hands of their trustees to be administered for their common benefits. These trusts were to be "benignly administered "440 large trusts like sugar trusts, the copper trusts, the shipping trusts, the tobacco trusts, the steel trusts, etc were created. Many experts do not differentiate between an outright merger and trusts agreements. Financial factors forced the end of the first merger wave. The stock market crash of 1904 and the panic in Banking of 1907 led to the closure of the many of the banks. The era of easy availability of finance, basic ingredients for takeovers, ended resulting in the halting of the first wave. Further the application of anti-trusts legislations, which was hitherto lax, became more rigorous. The federal Government under the stewardship of President Theodore Roosevelt (nick named as "trust buster") and subsequently under
  17. 17. President William Taft made a major crackdown on large monopolies .For example, Standard Oil was broken into 30 Companies such as Standard Oil of New Jersey (subsequently renamed Exxon), Standard oil of New York (subsequently renamed Mobil), Standard Oil of California (Subsequently renamed Chevron) and Standard Oil of Indiana (Subsequently renamed Amoco) Some of the current corporate leaders like General Electric (GE),Du Pont, Eastman Kodak, Navistar International are the products of the first wave. Second Wave: The Second merger wave occurred between 1916 and 1929.George Stigler, a winner of the Nobel prize in Economics, has contrasted the first wave as "merging for monopoly" and the second wave as "merging for oligopoly". The consolidation pattern resulted in the emergence of oligopolistic industrial structures. The second wave was primarily fueled by the post World War I boom in American economy and a buoyant capital market. The anti-trust environment was stricter with the passing of Clayton Act 1914.This result in several vertical mergers, where in firms involved did not produce the same results but had similar product lines. For Examples, Ford Motors became a vertically integrated company. It manufactured its own tyres for the cars from the rubber produced from its own plantations in Brazil. Further the bodies for the car were made from the steel, produced from its own steel plants. The steel plant in turn got iron ore from Ford's own mines and shipped on its own railroad. Several companies in unrelated business were also involved in mergers resulting in the formation of conglomerates. The industries, which witnessed disproportionately high merger activities, were food products, chemicals, primary metals, petroleum and transportation equipments. High level of consolidation was also observed in public utilities. The second merger wave lasted until the Great Depression. The wave ended with the stock market crash on the "Black Thursday". On 29th October 1929, the stock market witnessed one of the steepest stock price fall in history. The crash resulted in a loss of business confidence, curtailed spending and investment, thereby worsening the depression. The number of mergers witnessed a sharp decline after the crash. Firms were focusing on the basis survival and maintaining their solvency rather going for fresh acquisitions. Some of the corporate giants like General Motors, International Business Machine (IBM), Union Carbide, Hon Deere, etc, are a product of this era.
  18. 18. Allied Chemicals Corporation: Allied Chemicals Corporations, which came into existence during the second wave consolidation its control over five firms to the chemicals business namely General Chemicals, Barrette, Silvery Process, Semet-Solvay and National Aniline & Chemicals. All the Five firms operated in related businesses. General Chemicals was a combination of 12 producers of sculpture acid; Barrette sold by product of ammonia and coal tar producers; Solve Process was the America's largest producer of ash; Semet-Solvay traded in coal products and National Aniline & chemicals was America's largest seller of dyestuffs. All the five firms consolidated into single management structure undertheageis of Allied Chemical Corporations. Allied Chemical Corp, was able to derive economics of scale particularly in production process and Marketing. Third Wave: The third merger wave occurred during 1965 to 1969. This wave featured a historically high level of merger activity .One of the reason for the factor is that this wave occurred in the Background of a booming American economy. One of the new trends started by this wave was the acquisition of larger companies by smaller companies. In the waves prior to this, the acquirer was always bigger in size than the target. A large proportion of transaction that took place during this wave were conglomerate transactions. The conglomerates formed during this wave were highly diversified and simultaneously operated in several unrelated industries. For Example during the sixties ITT acquired such diversified business like car rental firms, bakeries, consumer credit agencies, luxury hotels, airport parking firms, construction firms, restaurant chains, etc. The bull market in the 1965s drove stock prices higher and higher. This resulted in the shares of certain companies getting high Price/Earning multiple. Potential acquirers realized that acquisitions through stock swaps (shares of the acquirer given in exchange for the shares of the target company) was an innovative way to increase earnings. This led to a famous bootstrap game.
  19. 19. Fourth Wave: The fourth wave occurred between 1981 and 1989.The most striking feature of this wave is the increasing emergence of hostile takeovers. Although the number of hostile deals were not very high, he figure is significant in terms of value of all M&As. The fourth wave can be distinguished from the previous waves by size and prominence of the target firms. Some of the largest firms in the world (Fortune 500 firms) because the target of acquirers. The average size of deals was substantially higher. The forth wave also witnessed the emergence of the professional corporate raider. The raider's income emanated from his takeover attempts. The word "attempt" signifies that very often the raider earns a handsome profits without taking control of the management of the target firms. For Example, Paul Bilzerian participated in various raids and earned huge profits without consummating a single transaction till he acquired Singer Corp in J988.Manv takeovers attempts were designed to sell the shares purchased bv the raider at a higher price. One method of the same was through Greenmail. (Greenmail involves forcing the target to buyback the shares from the raider at a hefty premium by threatening a takeover). In case the target did not succumb to the greenmail pressure, the raider would have succeeded in putting the stock "in play". This would result in the speculative demand for the shares in the secondary market, in anticipation of a takeover attempts. This would attract the attention of all potential acquirers towards the target. This would enhance the probability of the company being acquired though not by the original raider. This wave also resulted in a new class of speculators called the Arbitragers. They would buy the stock of the potential target firms in anticipation of a possible takeover. Their entry into a particular counter would put the scrip "into play". This would facilitate hostile takeovers, as they were always willing to sell their holdings to the highest bidder. The use of debt to finance acquisitions reached unprecedented proportions during the fourth wave. This was possible due to the emergence of junk bonds Junk bonds refer to the bonds, which are rated below investment grade or are unrated. The yield on the junk bonds was significantly higher than that of investment grade bonds. The higher yield resulted in the creation of virtually unlimited appetite for junk bonds. The ready availability of debt financing enabled even the small firms to acquire large established blue chip firms. This gave birth to the phenomena of leveraged buyouts
  20. 20. The aggressive role of investment bankers was one of the important factors in the fourth wave. M&A advisory services became a lucrative source of income for investment banks. Mergers specialists in investment banks and lawyer firms developed many techniques to facilitate and prevent takeovers. They pitched in for mandates from both potential targets and both potential acquirers for hiring their services to prevent or bring about takeovers. Some firms like Drexel Burnham Lambert specialized in the issue and trading of junk bonds. Lastly the wave was more global in nature. Hitherto merger activity was generally concentrated in the United States. The merger wave witnessed active participation from European and Japanese firms. Fifth Wave: The current merger wave began in 1992.This wave is marked by a large number of mega-merger and cross -border mergers. The major drivers for the current wave are deregulation, globalization and technology. The increasing levels of deregulation are enabling companies to expand their operations in the area, which has significant regulatory barriers. The process of privatization has also thrown up opportunities for the acquisition of erstwhile public sector firms. The phenomena of globalization are resulting in the dissipation of geographical barriers to entry. Many countries across the world (including India) are eliminating the obstacles that impeded the flow of foreign investments. Foreign firms often resort to major acquisition in the local market as entry strategy. Further with the reduction in the barriers to international trade, as a consequence of the setting of the WTO, firms have to be globally competitive to survive in the new economy. The emergence of interest and the intelligent application of the information technology have resulted in a paradigm shifts in the operations of firms. The sectors where the impact of the wave is most visible are telecommunications, entertainment and media, banking and financial services. The Acquisition Process
  21. 21. 1 Acquisition Search: The first step is to determine the universe of potential target companies. Information is gathered about these companies based on their published data, industry specific journals, databases, past prospectuses, etc. If the acquisition involves buying only part of the target company, segmental data may be difficult to obtain. Information about private companies may not be readily available. Once the universe is determined, targets may be short-listed based on certain parameters. 2.Approaching the Targets: This is one of the most delicate part of the deal. There are broadly two methods of approaching targets. ■S Passive Strategy: This approach is based on the premises that an overwhelming majority of the firms are not for sale and are unreceptive to any inquiries. The acquirer is unwilling to pursue any acquisition on an aggressive basis. In such an approach, the acquirer passively waits till the time a potential target is available for sale. S Active Strategy: This is more pro-active approach by the acquirer. The active approach may be either friendly or hostile. In the friendly way, a private and confidential line of communication may be opened with CEO, Director or the Investment Banker of the target company. It is also made clear if the target company is not interested, no further action will be taken. In the Hostile approach, the acquirer assumes the role of a raider and actually starts accumulating the shares of the target. This approach assumes that while the management may be averse to the takeovers, the shareholders would be receptive to the offer. When shares are accumulated by the acquirer, it is financially beneficial even if it outbid in a counter offer. 3. Valuation: Now the stage is set for valuing the Target Company. The overall process is centered around free cash flows and the Discounted Cash Flow (DCF) Model. Now the focus is on the finer points in calculating the valuation. In the book Valuation: Measuring and Managing the Value of Companies, the authors Tom Copland, Tim Koller, and Jack Murrin outline five steps for valuing a company: 1. Historical Analysis: A detail analysis of past performance, including a determination of what drives performance. Several financial calculations need to be made, such as free cash flows, return on capital, etc. Ratio analysis and benchmarking are also used to identify trends that will carry forward into the future. 2.Performance Forecast; It will be necessary to estimate the future financial performance of the target company. This requires a clear understanding of what drives performance
  22. 22. and what synergies are expected from the merger. 3.Estimate Cost of Capital: The need is to determine a weighed average cost of capital for discounting the free cash flows. 4.Estimate Terminal Value: Adding a terminal value to the forecast period to account for the time beyond the forecast period. Test & Interpret Results; Finally, once the valuation is calculated, the results should be tested against independent sources, revised, finalized, and presented to senior management. Valuation of the target company is the most critical part of the deal. A conservative valuation can result in collapse of the deal while an aggressive valuation may create perpetual problems for the acquiring company. Commonly used valuation methods are:  Discounted Cash Flow Method: In this method, valuation represents the present value of the expected stream of the future cash flow discounted for time and risk. This is the most valid methodology from the theoretical standpoint. However, it is very subjective due to the need to make several assumptions during the computation.  Comparable Companies Method: This method is based on the premise that companies in the same industry provide benchmark for valuation. In this method, the target company is valued vis-a vis its competitors on several parameters.  Book Value Method: This method attempts to discover the worth of the target company based on its Net Asset Value.  Market Value Method: This method is used to value listed companies. The stock market quotations provide the basis to estimate the market capitalization of the Company.
  23. 23. Acquirers rarely rely on a single method of valuation. Normally the target companies are value based on various methods. Different weightages are assigned to the valuation computed by various methods. This weighted average valuation helps in eliminating the errors that may creep in if a single method is relied on. 4.Negtiations: This is the process of formulation the structure of the deal. The merchant banker plays a vital role in closing the financial side of the negotiations. From a financial standpoint, the key elements of negotiations are the price and form of considerations. Both the elements are interrelated and affect the attractiveness of the deal. The acquirers must ensure that the final price paid should not exceed the perceived value of the target to the acquirer. 5.Due Diligence: The basic function of due diligence is to assess the benefits and the costs of a proposed acquisition by inquiring into all relevant aspects of the past, present and the predictable future of a business to be purchased .Due Diligence is of vital importance to prevent "unpleasant surprise" after completing the acquisition. The due diligence should be thorough and extensive. The due diligence exercise is carried out by a team of executive from the acquirers, their Investment Bankers Solicitors and Chartered Accountants. The team should have members with experience of all dimensions of the business like Finance, Marketing, Human Resources, Operations, Legal etc. The exercise should cover all material factors, which are likely to affect the future of the business. Due Diligence exercise covers careful study of information in public domain like financial statements, corporate records like minutes of meetings past prospectuses, share price movements etc. All contracts entered into by the firms with lenders, suppliers, customers, franchises, lease agreements, asset purchase agreements etc need to be carefully studied. Special attention should be given to litigations, contingent liabilities, environmental disputes, liens and encumbrances, product warranties inter company transactions, tax disputes, etc 6.Acquisition Finance: Acquisition may be paid for in several ways: all cash, all securities or a combination of cash and securities. The securities offered may be equity, preference shares or debentures. Further the debentures and the preference shares may be convertible. The cash may be raised from internal accruals, sale of assets, etc. It may also be financed by bank borrowings, public issue or private placements of debt and equity
  24. 24. shares. As timing is a critical factor in such deals, the investments bankers involved often gives/arranges for a bridge loan against subsequent refinancing. Sell-offs involve sale of assets or business entities. The assets may be tangible like manufacturing unit, product line etc. or intangible assets like brands, distribution network, etc. Sometimes the business entity as a whole may be sold to third party. The reasons for Sell-offs are varied. They can be broadly classified as:  Opportunistic: In such cases the vendor company has no intentions to divest in the normal course. However, the management is tempted by the buyers with a very high bid. If the company feels that the price offered is substantially more than worth of the assets/ business, it may divest. The reason for the sale is solely profit motives.  Forced: The reason for the sale is the prevalence of circumstances beyond the control of the company. The company may be facing a severe liquidity crunch and the only solutions to raise cash may be through divestiture. Sometime the assets/business may be sold to avoid takeovers or to make a takeover bid unattractive. Sometimes a divestiture may be a part of a rehabilitation package for turnaround of a sick company.  Planned: A company may plan for sale of a particular assets/business. The reasons may be varied: • Strategic decisions to exit from a certain industry. • Poor business fit with other operations of the company. • Severe competition. • Technological Factors • Continuous losses in a particular line of activity • Shrinking Margins • Personal reasons like retirement, family disputes, financial needs, etc. M&A's in MNE's -
  25. 25. A merger occurs when an exporter merges with a domestic company in the target market and creates a new entity. Under an acquisition, the exporting company takes over a domestic company in the target market. The domestic company may still trade under its own company name with ownership and direction controlled by the exporting company.
  26. 26. Advantages Disadvantages • Decreased time to access and penetrate target market as the existing company already has a product line to be exploited and a distribution network • Prevents an increase in the number of competitors in the market • Overcome entry barriers including restrictions on skills, technology, materials supply and patents. • Increased risk - may be a large financial commitment but faces political and market risks • Poor or slow post-merger integration • Target too large or too small • Overly optimistic appraisal of synergies • Overestimation of market potential • Inadequate due diligence • Incompatible corporate cultures Choosing a country A useful starting point in considering the location of any foreign direct investment is to take a wider view of distance than simply the distance from home measured in kilometers. For example: • Cultural distance - language, ethnicity, religion • Administrative distance - institutional weaknesses, government policies, political hostility • Geographic distance - lack of common border, physical remoteness, size of country • Economic distance - differences in consumer incomes, cost differences Decidingonalocation The main factor quoted by Australian firms as influencing their location decision is the size of the market. Exposure to a broader range of large and small markets increases the geographical base for revenue generation. Other reasons given as important to the location decision include: • Political stability - political history, fiscal and monetary policy • Economic stability - growth rates, incomes, costs, resources, interest rates and inflation
  27. 27. • Geographic borders- remoteness, size of country, population and climate • Infrastructure for transportation and communication • Business ethics - language, ethnicity and culture • Competitors and industry structure • Tax policy, tariffs and other trade barriers, incentives offered by government • Labor costs • Quality of potential local partners • Availability of local suppliers Management issues with market entry strategies • Uniqueness of product • International experience and knowledge of cultural issues • Barriers to entry • Designing a good business model • Is it cheaper to produce locally overseas or lo export? • Is it better to license to infiltrate more markets faster? • Have you insured against non-payment? • Haw to address legal issues or conflicts with partners • Have you got a plan for a currency increase? Key success factors for market entry strategy for service firms • Long-term commitment - CEO and Board (local office, training, promotional activities) . Relationship development (distributors, local government, JV partners) . Patience (government, culture, realistic time frames and budgets) • Prove the concept in Australia first - strong domestic client base to leverage (especially if internationally recognized) - Cheaper to get finance from domestic market • Uniqueness of product and IP protection • Strong reputation/confidence in ability • Prior international experience or recruit internally experienced people • In market presence - closeness to customer • Good interpersonal skills of staff/cultural understanding • Website up-to-date and informative to boost credibility
  28. 28. Forms of Corporate Downsizing: 1. Spin-Off: Spin-off has emerged as a popular form of corporate downsizing in the nineties. A new legal entity is created to takeovers the operations of a particular division or the unit of the company. The shares of the new units is distributed pro rata among the existing shareholders. In other words the shareholding of the new company at the time of the Spin-off will mirror the share-holding of the parent company. The shares of the new company are listed and traded separately on the stock exchanges, thus providing an exit route for the investors. Spin-Off does not result in cash inflow to the parent company. 2. Split-Off: In a split-off, a new company is created to takeover the operations of an existing division or unit. A portion of the shares of the parent company are exchanged for the shares of the new company. In other words, a section of shareholders will be allotted shares in the new company by redeeming their existing shares. The logic of split-off is that the equity base of the parent company should be reduced reflecting the downsizing of the firm. Hence the shareholding of the new entity does not reflect the share holding of the parent firm. Just as in split-off does not results in any cash inflow to the parent company. 3. Split-Up: A split-up results in a complete break-up of a company into two or more companies. All the division or units are converted into separate companies and the parent firm ceases to exist. The shares of the new companies are distributed among the existing shareholders of the firm. 4. Equity Carve outs: An equity carve outs involves conversion of an existing division or unit of wholly owned subsidiary. A part of the stake in this subsidiary is sold to a outsiders. The parent company may or may not retain controlling stake in the new entity. The shares of the subsidiary are separately listed and traded on the stock exchange. Equity Carve outs results in a positive cash flows to the parent company. An equity carve outs is different from spin-off because of the induction of outsiders of new shareholders in the firm. Secondly equity carve outs requires higher levels of disclosures and are more expensive to implement.
  29. 29. Divestitures: Divestitures involves outright sale of a portion of the firm to outsiders. The portion sold may be a division, unit, business or assets of the firm .The firm receives purchases consideration in the form of cash, securities or a combination of the two. The divestiture is the simplest form of Sell-offs. Legal Procedures for Merger, Amalgamations and Take-overs The control exercised by the government over mergers is articulated in an elaborate legal framework embodied in the Companies Act and the MRTP Act. The general law relating to mergers, amalgamations and reconstruction is embodied in sections 391 to 396 of the Companies Act, 1956 which jointly deal with the compromise and arrangement with creditors and members of a company needed for a merger. Section 391 gives the High Court the power to sanction a compromise or arrangement with creditors and members, subject to certain conditions. Section 392 gives the power to the High Court to enforce and supervise the carrying out of such compromises or arrangements with creditors and members. Section 393 provides for the availability of the information required by the creditors and members of the concerned company when acceding to such an arrangement. Section 394 makes provisions for facilitating reconstruction and amalgamation of companies. Section 395 gives power and duty to acquire the shares of shareholders dissenting from the scheme or contract approved by the majority. And Section 396 deals with the power of the central government to provide for an amalgamation of companies in the national interest. In any scheme of amalgamation, oath the amalgamating company or companies and use amalgamated company should comply with the requirements specified in sections 391 to 394 and submit details of all the formalities for consideration of the High Court. It is not enough if one of the companies alone fulfils the necessary formalities. Sections 394, 394A of the Companies Act deal with the procedures and the requirements to be followed in order to effect amalgamations of companies coupled with the provisions relating to the powers of the court and the central government in the matter of bringing about amalgamations of companies. After the application is filed, the High Court would pass orders with regard to the fixation of the dates of the hearing, and the provision of a copy of the application to the Registrar of Companies and the Regional Director of the Company Law Board in accordance with section 394A and to the Official Liquidator for the report confirming that the affairs of the company have not
  30. 30. been conducted in a manner prejudicial to the interest of the shareholders or the public. Before sanctioning the scheme of amalgamation, the court has also to give notice of every application made to it under section 391 to 394 to the central government and the court should take into consideration the representations, if any, made to it by the government before passing any order granting or rejecting the scheme of amalgamation. Thus the central government is provided with an opportunity to have a say in the matter of amalgamations of companies before the scheme of amalgamation is approved or rejected by the court. The powers and functions of the central government in this regard are exercised by the Company Law Board through its Regional Directors. While hearing the petitions of the companies in connection with the scheme of amalgamation, the court would give the petitioner company an opportunity to meet all the objections which may be raised by shareholders, creditors, the government and others. It is, therefore, necessary for the company to keep itself ready to face the various arguments and challenges. Thus by the order of the Court, the properties or liabilities of the amalgamating company get transferred to the amalgamated company. Under section 394, the court has been specifically empowered to make specific provisions in its order sanctioning an amalgamation for the transfer to the amalgamated company of the whole or any parts of the properties, liabilities, etc. of the amalgamated company. The rights and liabilities of the employees of the amalgamating company would stand transferred to the amalgamated company only in those cases where the court specifically directs so in its order. The assets and liabilities of the amalgamating company automatically gets vested in the amalgamated company by virtue of the order of the court granting a scheme of amalgamation. The court also make provisions for the means of payment to the shareholders of the transferor companies, continuation by or against the transferee company of any legal proceedings pending by or against any transferor company, the dissolution (without winding up) of any transferor company, the provision to be made for any person who dissents from the compromise or arrangement, and any other incidental consequential and supplementary matters to secure the amalgamation process if it is necessary. The order of the court granting sanction to the scheme of amalgamation must be submitted by every company to which the order applies (i.e., the amalgamating company and the amalgamated company) to the Registrar of Companies for registration within thirty days. Provisions in the MRTP Act The law relating to mergers also explicitly prescribed that any merger or amalgamation, which increased concentration of asset ownership, should not
  31. 31. be approved by the High Court. Thus wherever such a possibility existed the role of the High Court as the agency which ensured that a merger was not prejudicial to the interests of its members or the public was superseded by the role of the central government as an agency that safeguards the national interest. This was done under Section 23 of the MRTP Act. According to sub-section (2) of this section, Government approval for amalgamations was necessary in the following circumstances: (i) if one MRTP undertaking amalgamated with another undertaking; and (ii) if, on amalgamation of two or more undertakings, an undertaking came into existence which became remittable under the MRTP Act. As per the law, the power of the central government under section 23 of the MRTP Act overrode the power of the Court to sanction a scheme of merger or amalgamation under sections 391 to 396 of the Companies Act. According to this section, no scheme for the merger or amalgamation of an undertaking could be sanctioned by any Court or would be recognized for any purpose or would be given effect to unless the scheme for such merger or amalgamation had been approved by the central government under the specific provisions of this section. The owner of the undertaking had to make an application to the central government for the approval. The scheme of approval could not be modified without the previous approval of the central government. The approval of the central government was not necessary for the merger or amalgamation of interconnected undertakings (which were not dominant undertakings) if they produced the same goods or provided the same services. If one of the transacting parties is a non-resident Indian, then transfer of shares could be made only with the permission of the RBI. Finally, the provisions under the sections 23 and 24 of chapter 3 of MRTP Act were abolished in 1991. As a result, the MRTP commission does not play a role in mergers and acquisitions in the same manner in which it used to. But, it does play a role in cases where it believes that a merger or a take-over would lead to restrictive trade practices Regarding take over there were no comprehensive regulations to govern these activities until the new clauses 40A and 40B were incorporated in May 1990 although both the companies Act (section 395) and the MRTP Act (section 24) had provisions for corporate takeovers. According to this clause, any person who acquires 5% or more of the shares in a company must notify the stock exchange and when the holdings cross 10%, a public offer to purchase shares must be made. However, this agreement was restricted to only listed companies and was effective only when either of the parties in an acquisition was a listed company. In November 1994, the Securities and Exchange Board of India came out with SEBI (Substantial acquisition of shares and take-over) Regulation, 1994to regulate the take-over of the companies. But this code was inadequate to address all the complexities and therefore a new committee was set up tore view the present code. The committee under the chairmanship of P.N.Bhagwati suggested substantial modifications in the existing code. The important chan>pp*-atf -consolidation of holdings by an existing shareholder holding not less than10 percent of voting rights will be allowed; - Conditional bid will be allowed; -Acquirer will be required to deposit upfront 10 percent of the total consideration in an Escrow account; -Time limit for competitive bidding has been extended to 21 days; -The consideration shall be payable even by exchange and/ or transfer of secured instruments with a minimum of 'A' grade rating from a credit rating agency. The valuation of the instrument will be duly certified by an Independent category 1 merchant banker or a chartered accountant of 10 years standing - Acquisition of shares by the acquirer during offer period is permitted, except in case of conditional offer -Time schedule for each event in the take-over process has been specified; • Waiting for offer
  32. 32. letter by SEBI has been dispensed with. Thus the revised code is applicable to the take-overs through acquisition of control over a company irrespective of whether or not there has been any acquisition of shares or voting rights in the company whereas, the present code restricts its applicability to take- over through acquisition of shares or voting rights. However mergers and amalgamations constitute a subject matter of companies Act, 1956 and is outside the preview of SEBI. How is the valuation of a target company done in an M&A? Both sides of an M&A deal may have differing views about the worth of a target company: its seller will tend to value the company as high as possible, while the buyer will try to get the lowest price possible. There are, however, many legitimate ways to value companies. The most common method is to look at comparable companies in an industry, but dealmakers employ a variety of other methods and tools when assessing a Itargetcompany. Following are the commonly used methods for valuation of a company: One method is called comparative ratios. Acquirers may base their offers on the following two of the many comparative ratios: In the using the P/E (price-to-earnings) ratio, an acquirer makes an offer as a multiple of the earnings the target company is producing. Looking at the P/E for all the stocks within the same industry group will give the acquirer a good idea of what the target's P/E multiple should be. In the EV/Sales (price-to-sales) ratio, the acquiring company makes an offer as a multiple of the revenues, again, while being aware of the P/S ratio of other companies in the industry. Another method is the "replacement cost". In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity's sake, suppose the value of a company is simply the sum of all its equipment and staffing costs. The acquiring company can literally order the target to sell at that price, or it will create a competitor for the same cost. It, obviously, takes a long time to assemble good management, acquire property and get the right equipment. This method of establishing a price certainly wouldn't make much sense in a service industry where the key assets - people and ideas - are hard to value and develop. Then there is the discounted cash flow (DCF) method. A key valuation tool in M&A, discounted cash flow analysis determines a company's current value according to its estimated future cash flows. Forecasted free cash flows are discounted to a present value using the company's weighted average costs of capital (WACC). DCF is tricky to
  33. 33. get right, but few tools can rival this valuation method. Do investors stand to gain from mega-mergers? Not always, only a few top executives, investment bankers, and lucky stock market speculators get rich from mega-mergers. Quoting academic research, she states that the majority of big deals don't create any long-term shareholder value. According to a Purdue University study, when glamour companies acquire other companies, the stock for the acquiring company is likely to under perform comparable companies in the three years after the acquisition. Value acquirers, on the other hand, outperform their peers in the long term after the acquisition. The study defines a glamour company as one to which the stock market assigns a much higher value than the book value of its assets, in other words a company with a high market-to-book ratio. A value company is just the opposite - its book value is greater than the value of its stock. "Glamour companies are the blue-eyed boys of Wall Street," says Raghavendra Rau, assistant professor of management at Purdue's Krannert Graduate School of Management. "When their management announces an acquisition, both the market and the management have inflated views of their ability to manage the acquisition. The acquisitions tend to perform badly. Value companies, on the other hand, have performed poorly in the past. Their shareholders are more likely to be prudent in only approving acquisitions that actually create value." Big deals rarely generate long-term gains. Integrating two companies often takes longer than expected, yields fewer benefits, and causes more disruption than anticipated. Daren Fonda, citing data from a research firm, writes in Time that in the seven of the nine mergers valued at more than $50 billion, the acquirers share price fell 46% from the pre-merger levels. How can small investors then make money from mega mergers? The options are very few. Small investors usually tend to lose out in mega-mergers. Gregory Zuckerman writes in Wall Street Journal that for investors, the best way to make money at the takeover game usually is to be a holder of a company that receives a takeover offer. Gillette, for example, shot up 13% the day Procter & Gamble made the merger announcement. But for shareholders of the companies doing the buying, the M&resurgence has its perils. The sad reality is that most large mergers just don't work out, despite all the hoopla surrounding them, according to Zuckerman. At the same time, speculation on takeover targets is a risky proposition and shares shouldn't be purchased strictly on a hunch that a deal is looming, analysts say. Rather,
  34. 34. takeover potential is just another reason to consider a stock that otherwise looks attractive based on price and earnings potential. Why do mega-mergers not succeed as expected? One doesn't have to look far for reasons why mega-M&As fail. Top executives clash, synergies often aren't borne out and the heavy cost of the deals sometimes comes back to haunt buyers. James Fanton of the Brooklyn Law School says that in the heady days of the 1990s' market excesses, CEOs justified M&A deals with tales of "synergy," and used their over-inflated stock as acquisition currency. Boards went passively along. The professionals who worked on the deals did not intervene to question the wisdom of the mergers. Paid by the number of deals and deal size, investment bankers had no reason to caution CEOs about the risks of the transactions. Accountants and lawyers abandoned all pretensions of independent thinking and were only too happy to join in the feeding frenzy of large fees, says Fanton. And in the case of media mergers, the business press, itself owned by the firms that were created by these mergers, fawned over the CEOs and extolled the transactions. As an example, Fanton cites former Worldcom CEO Ebbers. Indian Scenario A total of 872 Indian companies merged or were taken over in the year up to November 30, compared with 565 deals worth 4.5 billion dollar in the same period in 2004, The Times reported, quoting research agency Thomson Financial. The merger and acquisition surge forms part of a broader economic boom in India, which has seen its 30-share benchmark stock market index (Sensex) nearly triple from 3,300 in March 2003 to 8,788.81 at yesterday's close.The index, which hit a record 9,033.99 points yesterday before falling back slightly after profit-taking, is likely to rise by as much as 18 per cent a year over the next few years, according to the Indian unit of Societe Generale, thebank. Foreign companies and institutional investors are pouring into India, which recorded an annual increase of 8 per cent in its GDP in the three months to October, according to figures published yesterday. The investors are attracted by India's burgeoning affluent classes, which have nearly tripled from 30 million households to 81 million in the past 10 years. India, which has particular strengths in IT, outsourcing and manufacturing, also has a young, well-educated population, many of whom speak English.
  35. 35. About half the country's population are under 25. Vodafone's 67 billion rupee purchase of a 10 per cent stake in Bharti Tele-Ventures, India's largest mobile phone operator, in October, is the largest foreign investment this year. The one billion pounds acquisition of Dabhol Power, the utility, by Ratnagiri Gas and Power is the largest takeover this year, according to Thomson Financial. Studies have confirmed the general apprehension that FDI inflows in the form of mergers and acquisitions (M&As) are in general of poorer quality as compared to Greenfield FDI inflows, in terms of their domestic capital augmenting potential, spillover benefits, competition and efficiency. This is because M&As do not always augment the stock of productive physical capital in the host country which would contribute to further growth. It is to be noted that Greenfield investment, by virtue of new entry, increases competition, while M&As most often lead to increases in economic concentration by reducing the number of active enterprises in the market. Even a successful M&A bid and its efficient implementation from the investors' point of view need not necessarily have a favorable impact on the economic development of the host country. The main reason for this is that the objectives of the concerned multinational corporations (MNCs) and those of the host economies do not necessarily coincide. The effects of the M&As, either directly or through linkages and spillovers, also depend on whether the investment is natural-resource-seeking, market- seeking, efficencyseeking or created-asset-seeking. In case the initial investment decision related to a merger or acquisition is taken on purely financial profitability considerations, without due regard for the economic benefits likely to accrue to the host country, the effects of such M&As cannot be expected to be beneficial for the host economy. China Siow Yue et al note that the "driving forces behind this M&A surge include increased corporate competition as a result of liberalization in many host country regimes, and the need to consolidate international business in the face of falling corporate profit margins. Recent declines in commodity prices and global overcapacity across a spectrum of industries have exacerbated this business consolidation trend". The motive- factor would also have an important bearing on the type and quality of the technology transferred. It is important for the developing countries, therefore, to not only see "whether" technology is being transferred, but also the "nature" of such transfer. The quality of the technology acquired cannot be ignored if one has to keep in mind the dynamic long-term development interests of the developing countries. Recent Mergers & Acquisitions Company Merged with/Acquired Reason/Benefits Polaris Merged with Orbi Tech Acquired IPR of Orbi Tech's range of Orbi Banking product suite.
  36. 36. Wipro Acquired Spectra mind Aimed at expanding in the BPO space, the acquisition gave Wipro an opportunity to run a profitable BPO business. Wipro Acquired global energy practice of American Management Systems It acquired skilled professionals and a strong customer base in the area of energy consultancy. Wipro Acquired the R&D divisions of Ericsson It acquired specialized expertise and people in telecom R&D. Wipro GE Medical Systems (India) It acquired IP from the medical systems company, which in turn gave it a platform to expand its offerings in the Indian and Asia Pacific healthcare IT market. Moksha Challenger Systems & X media Primarily aimed at expanding its customer base. The company also leveraged on the expertise of the companies in the BFSI space. Mphasis Acquired China- based Navion software Expanded its presence in the Japanese and the Chinese markets. It also plans to use it as a redundancy centre for its Indian operations. Mascot Systems Acquired US-based eJiva and Hyderabad-based Aqua Regia Expanded in size and leveraged on technical expertise of the acquired companies. Acquisitions have helped the company in offering multiple services and expanding its customer base considerably.
  37. 37. M & A in IT Sector TIS 15 years since the process of liberalization started, and India Inc. is on the path to building MNCs (Multi-National Companies) across the globe. It is the desire of every enterprise to go global through sales outlets and/or mergers and acquisitions. A variety of acquisition stories are doing the rounds in the media. Here are a few thoughts that could be handy in understanding the M&A domain. The facilitators of the M&A process spend more time on the financials and projected cash flows to arrive at a value to complete the transaction. The acquiring company is interested in non-financial facts that could impact the performance of the acquired company. It is thus equally desirable to spend quality time on such non-financial parameters. Intent/drivers : There are a variety of reasons for engaging in acquisitions. The integration of the acquired unit leads to success only when our actions match these intents. These are: P Consolidation: Buying the competition o Diversification: Increasing the value chain width o Parking: Benefit from arbitrage in unrelated areas o Repositioning: Synchronising with societal change o Paradigm pioneering: Betting on future technologies Architecture: What are we seeking with the acquisition? Many a time, the acquisition yields results through improved capabilities, technology, brand position, and so on. It is worthwhile for the acquiring entity to ask some questions before deciding on any unit: 3 Will the acquisition add to tangible assets (resources) and/or intangible assets (capabilities)? Where does value come from? Is it process efficiency, asset turnover, ability to expand (financial leverage) in new areas, or a combination? 3 Can human capital be assessed and indexed to establish a baseline? Are there metrics to measure capability growth? 3 How are talent retention and sustenance handled? Can they be replicated? Strategy map : It is desirable to have answers on the what, why, where, when, and how questions to
  38. 38. find a strategy fit with the proposed acquisition. — What: Value generation and delivery infrastructure — Why: Maslow's Hierarchy of Needs — security and/or recognition needs — Where: Leadership in demanding markets — When: Towards portfolio balance — How: With value fit, integration, and institutionalization Identification Identifying target companies is normally done through accounting firms as they are considered to have a broader knowledge of the markets. However, before engaging them, a framework needs to be developed to filter the lists generated by them. A sample of filters worth looking into are: o Relevance to the overall strategy o Size — turnover, territories, technologies o Infrastructure/platform (commodity products) or applications (custom-built products) o Stages in the business cycle (adolescence, youth, prime/peak) D With sustainable competitive advantage or for building competitive advantage o Geopolitical, civility, and ethical considerations o Regulatory, ecological, and infrastructure frameworks o Ease of exit, related costs and value loss Evaluation This is an area the views and issues are varied. Typical parameters for evaluation include customer, capital, brand, financials and liabilities. In addition, a few more parameters on the intangibles would add value: o Process and practice o Ethics, excellence, and eco-consciousness o Culture, communication, and commitment o TQM (6-sigma, BPR, CMM, ISO), and ERP/MIS Systems o IPR, time-to-market, and re-positioning Mechanics There are many experts one can consult with to obtain legal and environment
  39. 39. clearances, arrive at transaction value based on EBITDA/WACC vs. Market-cap, book- value, etc., structuring the transaction in terms of cash, stock, swap, etc., and negotiating for equitable gains to both the parties. Integration M&A in the economies that are comparable to India are as good as domestic acquisitions, and the issues are fewer. While venturing into acquisitions in the developed economies, the challenges are psychological and not just business-related. Many would resist a new boss (parent company) from an economy that is not at par with their economy. Often, businesses are bought based on brand, technology and, importantly, by future cash flows. If half (or a significant number) of the management team decides to leave, what value will remain with the business? The challenges of making it work multiply with the acquisition as the expectations run high from every corner. The role of the integrating agent will remain under the microscope until the objectives are met to everyone's satisfaction. To ensure single-point accountability, the acquired unit should be viewed as a subsidiary of the parent, and one business head should be appointed from the parent company. Communication with the members of the acquired unit should be structured and measured to get the best synergies from the teams. A quick audit should be done to reach the members of the management team and ensure consistent performance and effective people management. Reassurances must be given (maybe in writing, with the necessary caveats) to retain them through the integration process. High-performing employees would typically expect independence and continued respect. Guaranteeing this, within the framework of the overall strategy, would go a long way in making the integration process smooth. The members of the management team who do not fall under the above category should be eased out at the earliest to minimize/eliminate the spread of negative energy. This activity should be done in one go and not spread over time. Nobody likes to have bitter medicine more than once! Share with the team (remaining members of the management) the objectives of the acquisition, set the expectations, the measures, and develop the timetable with milestones to track integration. Involving them in creating the timetable would secure buy-in. Synergy
  40. 40. The synergy of the acquisition will be decided by the communication to the markets, customers, and other stakeholders. Often, internal acceptance is faster than the external acceptance. For example, HP acquired Compaq but the market sees the products differently. The Compaq products that competed with HP prior to the acquisition are viewed a notch below by the market, leading to value erosion. To gain market acceptance on the value delivered, joint positioning of the brands (basically kill one of the two brands) is needed, with changes to product design, ergonomics, and support systems. If mergers are on the cards, then compensation parity and management team rotation between the acquirer and the acquired is a must to gain synergy and bring about a unified culture. Often, the experience gained from one acquisition is not captured or documented as part of knowledge management to leverage at the time of future acquisitions. Just like post-implementation audits on projects, audits on acquisitions would highlight the lessons learned and add value to the organization and ensure the prevention of the same mistakes being committed. After all, a learning system is not expected to make the same mistake twice! Patterns of MNE Related M&A in India In tune with the worldwide trend, M&As have become an important conduit for FDI inflows in India in the recent years. Official figures on the relative importance of M&As in total FDI inflows are not published. But independent sources suggests that during 1997-99 nearly 40 per cent of FDI inflows in the country have taken the form of M&As by MNEs of existing Indian enterprises rather than Greenfield investments. As indicated earlier, until 1990, almost all of FDI inflows in the country took the form of Greenfield investments. To examine the sect oral distribution, motives, patterns etc. of MNE related M&As in the country, a database covering 256 deals entered into by foreign MNEs or by their controlled affiliates in India between March 1993 and 15 February 2000 has been compiled. The main sources of the information are reports in financial media and CMIE's Economic Intelligence Service. The database (hereafter RISICDRC database) defines deals as acquisitions if it involves taking over the operations of a going concern by the acquirer. Merger is defined to cover deals where the identities of enterprises involved are merged. Some of the acquisitions are followed by amalgamation of the acquired entity into the acquiring company. However, such deals are
  41. 41. classified as acquisitions. Following patterns emerge from analysis of the database. Table 1: Share of M&As iu FDI Inflows iu India Year FDI Inflows (S million) M&A Funds (S million) Share of M&A Fluids hi Inflows (°o) 1997 3200 1300 40.6 1998 2900 1000 34.5 1999 (Jan- Mar.) 1400 500 35.7 Total 7100 2800 39.4 Year Mergers Acquisitions Total 1993-94 4 9 13 1994-95 - 7 7 1995-96 - 12 12 1996-97 2 46 4S 1997-98 4 61 65 1998-99 2 30 32 1999-00 (upto Jan.00) 5 74 79 Total 17 239 256 Source : Kumar based on RIS Database Major Mergers & Acquisitions 200to^6b United States • Sprint; with Nextel • Verizon with MCI • Kmart; with Sears, Roebuck (Announced 17 November 2004) ( billion, 55% stock, 45% cash) • Hewlett-Packard; with Compaq (Announced Sept. 2001 - Final 1 2002) ($25 billion) ([5]) • NBC Universal; NBC and Universal • J .P. Morgan Chase, Bank One (announced January 14, 2004) billion, Stock: 100%, Cash: 0%) (SNL) •Procter & Gamble buy Gillette (2005, $54 billion) ([6]) • Bank of America; with Fleet Boston Financial (2003, $47 billion) ([7]) • Cingular and AT&T Wireless (Announced February - Final 16 Oct 2004) ($41 billion) • SBC and AT&T Completed November 18, 2005 Source: Economic Times. 23 December 199S and 21 June 1999. Table 2: MNE Related M&As iu India
  42. 42. • Macromedia Inc by Adobe Systems Inc ($3.4 billion; close 05 Dec 2005) • Paramount; acquiring DreamWorks for $3.1 billion • Walt Disney Company and Pixar, announced January 2006, $7 billion Europe • Vivendi Universal; Vivendi SA and Seagram (agreed 19 June 2000) ($32 billion, Stock: 100%, Cash: 0%) (The Tocqueville Connection, Law firm) • Galax Welcome with Smith Kline Beecham (2000) (US$76 billion) Major Mergers & Acquisitions 1990-1999 Acquirer and target, announcement date, deal size, share and cash payment. United States • AOL Time Warner; America Online and Time Warner (US$166 billion excluding debt, Stock: 100%, Cash: 0%) (PBS coverage, CNN) • Exxon Mobil; Exxon and Mobil Oil (Dec. 1998, $77 billion, Stock: 100%, Cash: 0%) (Suns Online, CNN) • Citigroup; Citicorp and Travelers Group (1999, $73 billion, Stock: 100%, Cash: 0%) (Cornell, Citigroup FAQ) • MCI Communications; with WorldCom; created MCI WorldCom (1997) ($44 billion, Stock: 100%, Cash: 0%) (Department of Justice, • Chevron Texaco; Chevron and Texaco ($35 billion) ([2]) • Walt Disney Company; with Capital Cities/ABC (1995) ($ 19 billion) • Monsanto; with Pharmacia & Upjohn • Pfizer; with Warner-Lambert • I . JDS Anaphase; with SDL • Union Pacific Railroad; with Southern Pacific Railroad • Venison; Bell Atlantic, GTE, and Air Touch Cellular
  43. 43. Europe • DaimlerChrysler; Daimler Benz and Chrysler (Announced May 1998 -Final 1998) ($35 billion) ([3]) • Vodafone; with Mannesmann (completed February 2000) ($130 billion) ([4]) • Total; with Petrofina, and Elf Aquitaine • BP; with Amoco (completed August 1998) ($ 11 Obn) Japan Mitsubishi UFJ Financial Group (merger of Mitsubishi Tokyo Financial and UFJ, $88 billion in combined market capitalization at the time of announcement). Major Mergers in the Telecom Sectors: Acquirer Target Vodafone Mannesmann MCI WorldCom Sprint Bell Atlantic GTE AT&T Macaw Cellular SBC Ameritech US West Global Crossing Bell Atlantic NYNEX SBC Pacific Telesis The Indian telecom industry witnessed the merger of Tata Cellular with Birla AT &T and Bharati Telecom's acquisition of JTM. Major Mergers in Media & Entertainment Sector Acquirer Targets American On-line Time Warner Viacom CBS Walt Disney Capital Cities AT&T Media One Time Warner Turner Broadcasting
  44. 44. After the worldwide peak in 2000 and subsequent decreases over the two following years, M&A activity in the world as a whole slightly increased in 2003. Globally the total number of operations reached 30 200 in 2003, against 29 300 in 2002 (an increase of 3%). The total number of operations involving the acquisition of a US company increased by 1% to 7 900 operations, due to an increase in domestic mergers and acquisitions. For the EU-25 the situation was different, with a decrease of 3.4% between 2002 (9 000 operations involving EU firms as a target) and 2003 (8 700 operations). The gap between the EU-25 and the USA may be explained in part by the delay in the economic recovery in the EU-15 Graph 1a : Evolution of MSA as target As a source of bidders (i.e. acquiring companies), the USA seem to have shown a slight recovery in the last two years with a higher number of acquisitions than the EU-25 in 2003 (8 153 against 8 100) Important differences between M&A and FDI statistics Broadly speaking, FDI includes M&A statistics, Greenfield investments, reinvested earnings and intra-company loans. However, the following issues should be noted. Firstly, M&As record capital transactions without deducting disinvestment while FDI data deduct disinvestment. Second, cross-border M&A may be financed by external and domestic settlements while FDI are financed by external settlements and reinvested earnings. Third, while M&As record all acquisitions of shareholdings of 5% I or more, only acquisitions of holdings of more than 10% of the capital I qualify as FDI M&A statistics in this note are based on data provided by Thomson Financial Services (TFS). The database covers all acquisitions of shareholdings of 5% or more and with a value over US$1 million as well as acquisitions for which the value is unknown. Although it endeavors to collect and present information, which is as complete as possible, the nature of the information makes the coverage somewhat arbitrary. This is because although major operations affecting publicly listed companies are often officially published, the numerous purchases of smaller or unlisted companies are more difficult to identify. Also, subjective assessments are often inevitable e.g. as regards the date and sect oral classifications of a merger and acquisition operation. In addition a number of conventions have been established when drafting this M&A note. Both completed and pending deals are i----1---1— 3 CI 02
  45. 45. taken into account. TFS are used for classification for the sectoral aspects of M&A (SIC classification, different from NACE classification). Moreover, sectoral activities are defined according to the target's main activity, as this is the activity most likely to interest the bidder and also because the targeted sector is the one in which the effects of an operation are likely to be the greatest. Finally it is important to note that the database does not contain value data for a significant number of deals. However these are mostly small deals since the value of large operations can usually be ascertained. The value data are therefore underestimated, though not by a large amount. Graph 1b : Evolution of M&A as bidder 17500 'EU-25-•us
  46. 46. The value of M&A has decreased in the world as a whole, the EU-25 and the USA since 1999-2000. Globally the total value decreased by 8.6% in 2003 to 1 365 billion euros. The decrease was 15.6% in the EU-25 and 4.2% in the USA . The decline in value of mergers can be attributed in part to weak the economic performance, concerns about international security, a pause in the consolidation of some industries and declining stock prices, but can also be seen as a correction of the exceptional surge in M&A during 1999-2000. The value of M&A has decreased in the world as a whole, the EU-25 and the USA since 1999-2000. Globally the total value decreased by 8.6% in 2003 to 1 365 billion euros. The decrease was 15.6% in the EU-25 and 4.2% in the USA . The decline in value of mergers can be attributed in part to weak the economic performance, concerns about international security, a pause in the consolidation of some industries and declining stock prices, but can also be seen as a correction of the exceptional surge in M&A during 1999-2000. Merger Control 'Merger Control' refers to the procedure of reviewing mergers and acquisitions under antitrust / competition law. Over 60 nations worldwide have adopted a regime providing for merger control. Merger control regimes are adopted to prevent anti-competitive consequences of concentrations (as mergers/takeovers are also known). Accordingly most merger control regimens provide for one of the following substantive tests: Does the concentration • substantially lessen competition? (US, UK) • significantly impede effective competition? (EU) • lead to the creation or strengthening of a dominant position? (Germany, Switzerland) In practice most merger control regimes are based on very similar underlying principles. Simplified, the creation of a dominant position would usually result in a
  47. 47. substantial lessening of or significant impediment to effective competition. While it is undisputable that a concentration may lead to a reduction in output and result in higher prices and thus in a welfare loss to consumers, the antitrust authority faces the challenge of applying various economic theories and rules in a legally binding procedure. Modern merger control regimes are of an ex-ante nature, i.e. the antitrust authority has the burden of predicting the anti-competitive outcome of a concentration. Risk in M&As 'A big mistake most acquirers make is to lay too much stress on strategic, unquantifiable benefits of deal. This results in overvaluation of the acquired company.' Eg- Tata Tea is believed to have paid millions of dollars more than the second highest when it acquired Tetley. It had a tough time servicing additional debt required for the buyout. Strategic issues in mergers and acquisitions VALUATION IDENTIFYING
  48. 48. SYNERGIES INTEGRATION Need for caution Quite clearly, major acquisitions have to be handled carefully because they leave little scope for trial and error and are difficult to reverse. The risks involved are not merely financial. A failed merger can disrupt work processes, diminish customer confidence, damage the company's reputation, cause employees to leave and result in poor employee motivation levels. A comprehensive assessment of the various risks involved must precede an M&A deal. The circumstances under which the acquisition may fail, including worst case scenarios, should be carefully considered. The ability of a merger to create value for shareholders must be examined carefully. As Sirower puts it neatly: "When you make a bid for the equity of another company, you are issuing cash or claims to the shareholders of that company. If you issue claims or cash in an amount greater than the economic value of the assets you purchase, you have merely transferred value from the shareholders of your firm to the shareholders of the target -right from the beginning." Acquirers often make two major blunders. One is the tendency to lay too much stress on the strategic, un-quantifiable benefits of the deal. This results in overvaluation of the acquired company leading to what is called the winner's curse. The second is the tendency to underestimate the challenges involved in integration. As a result, the actually realized synergies turn out to be short of projected ones. Many companies confidently project substantial cost savings before the merger. But they underestimate the practical difficulties involved in realizing them. For example, a job may be eliminated, but the person currently on that job may simply be shifted to another department. As a result, the headcount remains intact and there is no cost reduction. This is especially so in a country like India, where retrenchment is not very easy. Many a merger is finalized hoping that efficiency can be improved by combining the best practices and core competencies of the acquiring and acquired companies. Cultural factors may, however, prevent such knowledge sharing. The DaimlerChrysler merger is a good example. Also, it may take much longer to generate cost savings than anticipated. The longer it takes to cut costs, the lesser the value of synergies generated. If generating savings is not easy, revenue growth - the reason given to justify many mergers - is even more difficult. In fact, growth may be adversely affected after a merger if customer or competitor reactions are hostile. When Lockheed Martin acquired Loral, it lost business from important customers such as McDonnell Douglas, who were Lockheed's competitors. So, companies must also look at the acquisition in terms of the impact it makes on competitors and the possibility of their retaliation. Some M&A experts consider revenue enhancement to be a soft synergy and discount it heavily while calculating synergy value. Companies making an acquisition not only have to meet performance targets the market already expects, but also higher targets implied by the acquisition premium. When they pay acquisition premium, managers are essentially committing themselves to delivering more than what the market expects on the basis of current projections. More often than not, the acquirers fail to discharge this commitment. Even when the numbers do not justify an acquisition, executives may insist on going ahead for strategic, un-quantifiable benefits. In the heat of finalizing the deal, what is conveniently overlooked is that
  49. 49. most strategic benefits ultimately should lead to some form of cost reduction or revenue growth. We should note some special problems that can influence the valuation calculation - Private Companies; When valuing a private company, there is no marketplace for the private company. This can make comparisons and other analysis very difficult. Additionally, complete historical information may not be available. Consequently, it is common practice to add to the discount rate when valuing a private company since there is much more uncertainty and risk. Foreign Companies: If the target company is a foreign company, you will need to consider several additional variables, including translation of foreign currencies, differences in regulations and taxes, lack of good information, and political risk. Your forecast should be consistent with the inflation rates in the foreign country. Also, look for hidden assets since foreign assets can have significant differences between book values and market values. Complete Control: If the target company agrees to relinquish complete and total control over to the acquiring firm, this can increase the value of the target, he value assigned to control is expressed as: CV = C + M CV: Controlling Value C: Maximum price the buyer is willing to pay for control of the target company M: Minority Value or the present value of cash flows to minority shareholders. the merger is not expected to result in enhanced values (synergies), then the squiring firm cannot justify paying a price above the minority value. Minority due is sometimes referred to as stand-alone value.
  50. 50. MERGERS & ACQUISITIONS (M&A) IN INDIAN TELECOM INDUSTRY Mergers and Acquisitions (M&A) are strategic tools in the hands of management to achieve greater efficiency by exploiting synergies and growth opportunities. Mergers are motivated by desire to grow inorganically at a fast pace, quickly grab market share and achieve economies of scale. India has become a hotbed of telecom mergers and acquisitions in the last decade. Foreign investors and telecom majors look at India as one of the fastest growing telecom markets in the world. Sweeping reforms introduced by successive Governments over the last decade have dramatically changed the face of the telecommunication industry. The mobile sector has achieved a tele density of 14% by July 2006 which has been aided by a bouquet of factors like aggressive foreign investment, regulatory support, lower tariffs and falling network cost and handset prices.M&A have also been driven by the development of new telecommunication technologies. The deregulation of the industry tempts telecom firms (telcos) to provide bundled products and services, especially with the ongoing convergence of the telecom and cable industries. The acquisition of additional products and services has thus become a profitable move for telecom providers. REGULATORY FRAMEWORK M&A in telecom Industry are subject to various statutory guidelines and Industry specific provisions e.g. Companies Act, 1956; Income Tax Act, 1961; Competition Act, 2002; MRTP Act; Indian Telegraph Act; FEMA Act; FEMA regulations; SEBI Takeover regulation; etc. We will cover some of these regulations hereunder which are unique to Top M&A deals in 2001 Target Acquirer Value of deal ($ millions) AT & T Broadband & Internet (US) Comcast(US) 57,547 Hugs electronics (US) Echo star Communications (US) 31,739 Compaq Computers (US) (US) Hewlett Packard (US) 25,263 American General (US) American International Group (US) 23,398 Dresdner ankh (Germany) Aliens (Germany) 19,656 Bank of Scotland (UK) Halifax Group (UK) 14,904 Wachovia (US) First Union (US) 13,132 Benicia (Mexico) City Group (US) 12,821 Telecom Italia (Italy) Olivetti (Italy) 11,973 Billiton (UK) BHP (Australia) 11,511
  51. 51. the telecom industry. TRAI Recommendations Telecom Regulatory Authority of India (TRAI) is of the view that while on one hand mergers encourage efficiencies of scope and scale and hence are desirable, care has to be taken that monopolies do not emerge as a consequence. TRAI had issued its recommendation to DoT in January 2004 regarding intra circles Mergers & Acquisitions which were accepted by DoT and stated below. DoT Guidelines Department of Telecommunications (DoT) can be credited with issuing a series of liberalizing initiatives in telecom sector which has led to phenomenal growth of the Industry. Based on recommendations of TRAI, DoT issued guidelines on merger of licenses in February 2004. The important provisions are state below: Prior approval of the Department of Telecommunications will be necessary for merger of the license. The findings of the Department of Telecommunications would normally be given in a period of about four weeks from the date of submission of application. Merger of licenses shall be restricted to the same service area. There should be minimum 3 operators in a service area for that service, consequent upon such merger. Any merger, acquisition or restructuring, leading to a monopoly market situation in the given service area, shall not be permitted. Monopoly market situation is defined as market share of 67% or above of total subscriber base within a given service area, as on the last day of previous month. For this purpose, the market will be classified as fixed and mobile separately. The category of fixed subscribers shall include wire-line subscribers and fixed wireless subscribers. Consequent upon the merger of licences, the merged entity shall be entitled to the total amount of spectrum held by the merging entities, subject to the condition that after merger, the amount of spectrum shall not exceed 15 MHz per operator per service area for Metros and category ‘A’ service areas, and 12.4 MHz per operator per service area in category ‘B’ and category ‘C’ service areas. In case the merged entity becomes a “Significant Market Power” (SMP) post merger, then the extant rules & regulations applicable to SMPs would also apply to the merged entity. TRAI has already classified SMP as an operator having market share greater or equal to 30% of the relevant market. In addition to M&A guidelines, DoT has also issued guidelines on foreign equity participations and management control of telecom companies. The National Telecom