Analysis of M&A

1. MERGER & ACQUISITION AND TYPES OF
SYNERGY
By 1.Ritik 6511 2.Pawan 6520 3.Manav 6521 4.Virender 6522 5.Anmol 6559

2. Mergers and Acquisitions
◦ Mergers and acquisitions (M&A) is a general term used to
describe the consolidation of companies or assets through
various types of financial transactions, including mergers,
acquisitions, consolidations, tender offers, purchase of assets and
management acquisitions. The term M&A also refers to the
desks at financial institutions that deal in such activity.

3. Merger
A merger describes two firms of approximately the same size, who join forces to move forward as a single new entity, rather than remain
separately owned and operated. This action is known as a "merger of equals." Both companies' stocks are surrendered and new company
stock is issued in its place.
Like, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, Daimler Chrysler, was created. A
purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies.

4. Types of Mergers
based on the relationship between the two companies involved in the deal
◦ Horizontal merger: Two companies that are in direct competition and share the same product lines and markets.
◦ Vertical merger: A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker.
◦ Congeneric mergers: Two businesses that serve the same consumer base in different ways, such as a TV manufacturer and a cable
company.
◦ Market-extension merger: Two companies that sell the same products in different markets.
◦ Product-extension merger: Two companies selling different but related products in the same market.
◦ Conglomeration: Two companies that have no common business areas.

5. Mergers may also be distinguished by following
two financing methods
◦ Purchase Mergers: This kind of merger occurs when one company purchases another company. The
purchase is made with cash or through the issue of some kind of debt instrument. The sale is taxable, which
attracts the acquiring companies, who enjoy the tax benefits. Acquired assets can be written-up to the actual
purchase price, and the difference between the book value and the purchase price of the assets
can depreciate annually, reducing taxes payable by the acquiring company.
◦ Consolidation Mergers: With this merger, a brand new company is formed, and both companies are
bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

6. Example
Vodafone and Mannesmann
This merger, which took place in 2000, was worth over $180 billion and is the largest merger and acquisition deal in history.
In it, U.K.-based Vodafone acquired German company Mannesmann. As a result, Vodafone became the largest mobile
operator in the world while setting the stage for future deals in the telecom industry. Many Germans were against this deal
because they wanted German businesses to remain key players in the global marketplace.
The deal was significant because it signaled the telecom boom as mobile phones began increasing in popularity. However, it
was not ultimately successful. “After Mannesmann rejected Vodafone’s first offer, Vodafone had to nearly double its offer.
Unfortunately, the combination didn’t work out the way Vodafone hoped, and as a result, it had to write off tens of billions
of dollars in the following years because of it,” Business Insider explains.

8. Valuation Matters
Both companies involved on either side of an M&A deal will value the target company differently. The seller will obviously value the
company at the highest price as possible, while the buyer will attempt to buy it for the lowest possible price. Fortunately, a company can be
objectively valued by studying comparable companies in an industry, and by relying on the following metrics:
◦ Comparative Ratios: The following are two examples of the many comparative metrics on which acquiring companies may base their
offers:
◦ Price-Earnings Ratio(P/E Ratio): With the use of this ratio, an acquiring company makes an offer that is a multiple of the earnings of
the target company. Examining the P/E for all the stocks within the same industry group will give the acquiring company good guidance for
what the target's P/E multiple should be.

9. ◦ Enterprise-Value-to-Sales Ratio (EV/Sales): With this ratio, the acquiring company makes an offer as a multiple of the
revenues, again, while being aware of the price-to-sales ratio of other companies in the industry.
◦ 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.
◦ Discounted Cash Flow (DCF): 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 (net income +
depreciation/amortization - capital expenditures - change in working capital) are discounted to a present value using the
company's weighted average costs of capital (WACC).

10. Acquisition
When one company takes over another entity, and establishes itself as the
new owner, the purchase is called an acquisition. From a legal point of
view, the target company ceases to exist, the buyer absorbs the business,
and the buyer's stock continues to be traded, while the target company’s
stock ceases to trade.
Unfriendly deals, where target companies do not wish to be purchased, are
always regarded as acquisitions.

11. Types of acquisition?
1. Friendly Acquisition
2. Reverse Acquisition
3. Black Flip Acquisition
4. Hostile Acquisition

12. Friendly Acquisition
◦ Both the companies approve the acquisition under friendly terms.
◦ Examples
◦ Reliance takeover of Hamleys.
◦ 620 Crores

13. Reverse Acquisition
◦ A private company takes over a public company
Example
◦ Clear wire and XOHM

14. BACK FLIP ACQUISITION
◦ The purchasing company becomes a subsidiary of the
purchased company.
Example
◦ Texas air composites and continental airlines

15. Hostile Acquisition
◦ Here, the entire process is done
by force.
Example
◦ Larsen & Turbo hostile takeover of Mindtree.

16. Basis for comparison between Mergers
vs Acquisitions
Merger Acquisition
Definition
The merger is a process in which more than one
companies come forward to work as one.
The acquisition is a process in which one
company takes control of another company.
Terms Considered to be friendly and planned.
Considered to be hostile and sometimes
involuntary (not always)
Title A new name is given.
The acquired company comes under the name
of the acquiring company.
Scenario
Two or more companies that consider each other
on equal terms usually merge.
Acquiring company is always larger than the
acquired company.
Power
The power-difference is almost nil between two
companies.
Acquiring company gets to dictate terms.
Stocks Merger leads to new stocks being issued. In acquisition, there are no new stocks issued.
Example
Merging of Glaxo Wellcome and SmithKline
Beecham to GlaxoSmithKline
Tata Motors acquisition of Jaguar Land Rover

17. S
Y
N
E
R
G
Y

18. Question 1
Consider the two firms that operate independently and have the following characteristics:
X Ltd. Y Ltd.
Revenues 8000 5000
Cost of Goods Sold
(COGS)
4500 2000
EBIT 3500 3000
Expected Growth Rate 7% 5%
Cost of Capital 8% 7%
Both firms are in steady state with capital spending offset by depreciation. Both firms have an effective tax rate of 30% and free
financed only be equity. Consider the following two scenarios:
Scenario 1: Assume that combining of firm will create economies of scale that will reduce the COGS to 40% revenues.
Scenario 2: Assume that as a consequences of the merger the combined firm is expected to increase its future growth to 7% while
COGS will be 70%.

19. It is given that Scenario 1 & 2 are mutually exclusive.
You are required to:
a) Compute the values of both the firms as separate entities.
b) Compute the value of both the firms together if there were absolutely no synergy at all from the merger.
c) Compute the value of cost of capital and the expected growth rate.
d) Compute the value of synergy in Scenario 1 and Scenario 2.
Answer
a) Value of X Ltd. = (FCFF (1+g))/( Ke – g) = EBIT (1-t) (1+ 0.07) / (0.08 -0.07)
= 3500 (1-.30)(1+.07)/ 0.01
= Rs 2,62,150
Value of Y Ltd. = (FCFF (1+g))/( Ke – g) = EBIT (1-t) (1+ 0.05) / (0.07 -0.05)
= 3000 (1-.30)(1+.05)/ 0.02
= Rs 1,10,250

20. b) Value of both firms without synergy = Rs 2,62,150 + Rs 1,10,250
= Rs 3,72,400
c) Cost of Capital = (8% x 2,62,150/3,72,400 ) + (7% x 1,10,250/3,72,400)
= 0.056 +0.020
= 0.076 or 7.6%
Expected growth = (7% x 2,62,150/3,72,400 ) + (5% x 1,10,250/3,72,400)
= 0.049 + 0.015
= 0.064 or 6.4%

21. d)
Calculating of Value of Synergy Scenario 1 Scenario 2
Revenues 13,000 13,000
Cost of goods Sold 5,200 9,100
EBIT 7,800 3,900
PAT (EBIT x (1-Tax Rate)) 5,460 2,730
Growth Rate 6.4% 7%
Cost of Capital 7.6% 7.6%
A. Value = (PAT ( 1 + g)) / (Ke – g) 4,84,120 4,86,850
B. Value of firm without synergy 3,72,400 3,72,400
C. Value of synergy (A-B) 1,11,720 1,14,450