Fundamentals of Mergers with some real life Indian cases

1. Corporatisation of Non Corporate Entity, Conversion of
Proprietary Concern & Partnership to Company
and
Corporate restructuring
by
CA. Nitant Trilokekar
nitanttrilokekar@yahoo.com

2. Why convert to Company






Limited liability (exp to Bankers)
Greater borrowing power
Market profile
Internal settlement
Employee stability new technology
organisations
Vehicle for acquisitions and mergers

3. Procedure for Conversion of
partnership firm into company
The firm may be converted into a company by following the
provisions of Part IX of the Companies Act, 1956
Sections 565 to 581 prescribes the law and procedure
Advantage : business can be run under the same name
Incorporate a company which can legally take over the business of
the firm and continue the same business under Part IX of the
Companies Act, 1956

4. Key Conditions




All partners of the partnership firm shall become shareholders of
the company in the same proportion in which their capital
accounts stood in the books of the firm on the date of the
conversion.
The partners receive consideration only by way of allotment of
shares in company
and The partners share holding in the company in aggregate is
50% or more of its total voting power
and continue to be as such for 5 years from the date of
conversion.

5. Key Requirements





Minimum Share Capital shall be Rs. 100,000 (INR One Lac)
for conversion into a Private Limited Company
Minimum Share Capital shall be Rs. 500,000 (INR five Lac)
for conversion into a Public Limited Co.
If the above requirement is not fulfilled by the firm, then
the Partnership deed should be altered Minimum 7
Shareholders
Minimum 2 Directors (for Private Limited Co.) and 3
Directors (for Public Limited Co.)
The directors and shareholders can be same person DIN
(Director Identification Number) for all the Directors DSC
(Digital Signature Certificate) for two of the Directors

6. Key Benefits







Automatic Transfer
All the assets and liabilities of the firm immediately
before the conversion become the assets and liabilities
of the company.
No Stamp Duty
No instrument of transfer is required to be executed
and hence no stamp duty is required to be paid.
No Capital Gain Tax
Continuation of Brand Value
Carry Forward and Set off Losses and Unabsorbed
Depreciation

7. STEPS FOR INCORPORATION OF
COMPANY UNDER PART IX

Partner’s meeting
•
•
•
Ascent of majority not less than 3/4
Authorize one or more partners
Execute a supplementary Partnership Deed to





atleast 7 partners
registered with the Registrar of Firms
fixed capital
provision of converting a firm into company
agreement by the partners to convert the partnership
to a company.
• Execute a settlement deed.

8. Mergers & Acquistions

9. Acquisitions and Restructuring
 Very popular strategy during the 20
th
Century.
 55,000 acquisitions in the 1980s worth $1.3 trillion.
 Pace of acquisitions picked up in the 1990s.
 40-45 of acquisitions in recent years involved cross-border transactions.
 India commenced in a large way after conversion of Rupee

10. Why restructure?

11. Restructure defined


Restructuring may include company
reorganisation, closure, insolvency, merger &
acquisition, downsizing, externalisation and
delocalisation.
Restructuring is driven by several factors
including a more open global economy,
downturns in economic growth, an ageing
population, introduction of new technologies
affecting ways of working and the necessity to
combat climate change and to reduce
environmental impact.

12. When does the corporate restructure?

When a company is having trouble making
payments on its debt, it will often consolidate and
adjust the terms of the debt in a debt
restructuring.
What does it aim to restructure?


A company restructures its operations or structure by
cutting costs, such as payroll, or reducing its size through
the sale of assets.
After a debt restructuring, the payments on debt are more
manageable for the company and the likelihood of payment
to bondholders increases.

13. Types of
Restructure

14. Antecedents (Triggers) of Restructuring
Environment
Governance
Restructuring
Strategy
Performance
Financial
Restructuring
14

15. Environmental
Environmental
- Competition
- Takeover threats
- tax motivations
Governance -- Weak governance
•
•
•
•
Ineffective management
Complacent board
Inadequate incentives
Lack of ownership concentration (institutional investor
activism).
15

16. Triggers for Re-structuring
Strategy
-
Poor strategy or implementation
Overdiversification
Leverage
Performance
-
Poor or declining performance
Difference between desired and actual performance
Assets are undervalued
Perceived threat of takeover
16

17. Financial restructuring
- LBOs (divisional MBOs)
- Employee stock options plans (ESOPs)
- Equity financed share repurchases
- Targeted share repurchases (greenmail)
•
•
•
•
Leveraged recapitalizations
Leveraged cash-outs
Leveraged share repurchases
Securities swaps (debt for equity)
17

18. Modes of restructuring
 Asset restructuring
- Downsizing
•
•
•
•
•
Employee layoffs
Mixed results
89% cite expense reduction (46% succeeded)
67% for competitive advantage (19% succeeded)
Which employees leave or stay?
- Downscoping
•
•
•
Divestitures (sell-offs, spin-offs, split-ups)
Plant closings
Liquidations
18

19. Divestitures (sell-offs versus spin-offs)
Spin-off
 Spin-off represents a pro-rata distribution of shares of a
subsidiary to shareholders.
 Occurs within the hierarchy.
 Terms and valuation of the assets are set internally
 Parent stockholders create new board
 Parent can maintain ties with spun-off unit.
Sell-off (De merger)
 Sell-offs: Assets are sold to another firm for cash and/or
securities.
 Occurs outside the hierarchy.
 Value determined by market forces.
 Acquiring firm absorbs and governs the sold-off assets as
part of its hierarchy.
19

20. MERGER

The aspect of corporate strategy, corporate finance and
management dealing with the buying, selling and
combining of different companies that can aid, finance, or
help a growing company in a given industry grow rapidly
without having to create another business entity.

A merger can resemble a takeover but result in a new
company name (often combining the names of the original
companies) and in new branding; in some cases, terming
the combination a "merger" rather than an acquisition is
done purely for political or marketing reasons.

21. Acquisitions and Restructuring
 Acquisition Types:
• Mergers:
 Two firms join and integrate operations as co-equals.
 Chrysler – Diamler Benz example.
•
Acquisitions:
 One firm buys a controlling interest in another firm with the intent to
make the other firm a division or subsidiary of the acquiring firm.
 In general these agreements are friendly but do not result in a co-equal
relationship.
 Novell’s acquisition of German-based SuSE gives Novell an in-house
source for Linux desktop and server operating systems.
• Hostile Takeovers:
 Acquisition bid is unsolicited.
 Generally results in incumbent management being removed.
 Yahoo’s takeover bid for HotJobs to thwart TMP Worldwide
(a rival of Yahoo).
Microsoft’s alliance with Yahoo to thwart entry of Google is NOT a merger

22. Rationales for Making Acquisitions
Increase
market power
Learn and develop
new capabilities
Overcome
entry barriers
Reshape firm’s
competitive scope
Acquisitions
Cost of new
product development
Increase
diversification
Increase speed
to market
Lower risk compared
to developing new
products

23. f
6o
e
t
Pag d ou
n
ha
Mergers
Classification of Mergers
 Horizontal Mergers
 Vertical Merger
 Market Extension Merger
 Product extension Merger
 Concentric Merger
23

24. CLASSIFICATIONS OF
MERGERS
Horizontal merger - Two companies that are in direct
f
6o
e
a g o ut
P
nd
ha

competition and share similar 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.

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
24
business areas.

25. f
7o
e
a g o ut
P
nd
ha

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
Distinction between
Mergers and Acquisitions
When one company takes over the
other and the target ceases to exist.
In a MERGER 2 firms of same size
decide to go forward as a new
company. – Merger of equals
Mergers are often friendly while
acquisitions are hostile - usually.
25

26. Top 12 Indian cross border acquisitions
Sr.
Acquisition
Country
Deal Size
1.
Tata Group Acquired Corus, Oct. 2006
United Kingdom
$12.98 billion
2.
Bharti Airtel acquired Zain Africa, Feb 2010
Kenya
$10.7 billion
3.
Hindalco Industires acquired Novelis , Feb 2007
Canada
$5.73 billion
4.
ONGC acquired Kashagan Oilfields, November 2012
Kazakhstan
$5 billion
5.
ONGC acquired Imperial Energy, August 2008
United Kingdom
$2.62 billion
6.
Tata Motors acquired Jaguar Cars and Land Rover March
2008
United Kingdom
$2.3 billion
7.
Tanti Group of Companies and Arcapita Bank BSCc
acquired Honiton EnergyApril 2010
China
$2 billion
8.
Adani Enterprises acquired Port Terminals, May 2011
Australia
$1.97 billion
9.
Essar Global acquired Algoma Steel, April 2007
Canada
$1.79 billion
10.
Reliance Industries acquires Oil & Gas Assets (Marcellus
Shale), April 2007
United States
$1.7 billion
11.
Indian Hotels Co acquired Orient-Express Hotels, October
2012
Bermuda
$1.67 billion
12.
Essar Global acquired Minnesota Steel, April 2007
United States
$1.65 billion

27. World's largest steel maker and the third richest man in
the world.(after Bill Gates and Warren Buffet)
world.(
•
•
•
Lakshmi Mittal :Born on
June 15, 1950 at Sadulpur,
in Churu district of
Rajasthan, in a poor family.
Mittal Steel is the largest steel maker in the
world.
After the merger between Mittal Steel and
Arcelor which raged a big debate throughout
the Europe, Laxmi Mittal current controls 10%
of the global steel production
The combined entity post-merger is three
times the size of its nearest competitors.
Kensington mansion
27

28. Testing the Gains of Merger

Product market test
• effect of mergers directly on consumers and
indirectly on stockholders of merging firms.

Stock market test.
• effect of mergers directly on stockholders of
merging firms and indirectly on consumers.

There is a linkage between the two.
28

29. Alternative ways to measure

Event Studies
• compare stock prices of the firms a
certain days before and after the
mergers.

Regression Analysis
• tax rate of return as dependant variable
and Size of the firm, rate of increase in
capital stock, R&D expenditures etc. as
independant variables.

T Test
• Paired two samples for mean
29

30. a
yad
fa
uAa ?
h
aa
yof test
Logic
@
Quantitative Measurement of success
of merger
Remarks
Addition of profits of both companies after
merger to be higher than any one before
merger.
Addition is child’s play. The synergy
should drive the profit accrual much
more than that.
Cost of production to produce per
rupee sale
Economies of scale should drive the
cost down due to better bargaining.
Net Profit Margin
Cost saving and economies of scale
should drive up the profit ratio.
Net Profit/Share Capital incl. Free reserves
The ultimate translation of objective of
any business.
Net Profit + Depreciation / Capital
Cash profits translate better
Net Profit / Total of Balance sheet
How you have managed your total
assets
30

31. Who is this and are these
acquisitions or mergers



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




Originated in Burma in 1890s (Mynamar)
Started as moneylender but by independence entered into
insurance, rubber, stockbroking, textiles.
1949 Collaborated with UK’s Tube investments to form Tube
Investments of India – Bicycles
Vertically integrated into tubes, strips, lamps & chains
1954 Carborandum Universal association with Carborandum
USA. Later made its own Raw Material (Bauxite) mining etc.
1979 Floated Public issues to implement expansion strategies
1981 acquired EID Parry having diversified base – ceramic,
confectionery, fertilisers, electronics. Turned it around.
Ventured into new businesses like bio pesticides, ceramic
colour, Information Technology
The only Indian Company to win IMD award in 2001 for Best
run Family Business.
31

32. 32

33. The major companies of the Group are:
Carborundum Universal Limited
Cholamandalam DBS Finance Limited
Cholamandalam MS General Insurance
Coromandel Fertilisers Limited
EID Parry India Limited
Tube Investments of India Limited
Parry Agro Industries Limited
Ambadi Enterprises Ltd
Cholamandalam Distribution Services Ltd
Cholamandalam Mutual
Cholamandalam MS Risk Services Ltd (CMSRSL)
Cholamandalam Securities Ltd
Coromandel Engineering Company Ltd
Kadamane Estates Company
Laserwords Pvt Ltd
Murugappa Morgan Thermal Ceramics Ltd
Net Access India Pvt Ltd
New Ambadi Estates Pvt Ltd
Parry Enterprises India Ltd
Parry Murray and Co Ltd
Placon (India) Pvt Ltd
Polutech Ltd
Prodorite Anticorrosives Ltd
Southern Energy Development Corporation
Sterling Abrasives Ltd
Wendt India Ltd
33

34. Problems With Acquisitions
Inadequate
evaluation of target
High degree of Leverage
Resulting firm
is too large
Acquisitions
Managers overly
focused on acquisitions
Too much
diversification
Inability to
achieve synergy
Integration
difficulties
34

35. f Shaking off Hostile
3o
1
ge outs
Pa d
n  Corporate Restructuring
ha
•
Take over Shark repellents
Involuntary restructuring (tender offer)
 Options are similar to voluntary restructuring but more immediate.
 Actions designed to thwart the takeover.
- Financial
•
•
•
•
Poison pills
Leveraged recapitalizations
Greenmail
Litigation
- Asset
• Scorched earth defense - defensive asset restructuring
• Crown jewel sales - sell sought after unit
• Pac-man defense - target launches attempt to acquire bidder
- Third Party
• White knight defense
• Other bidder (competitive bid situation)
35

36. Pa
ha ge 1
nd 3
ou of
ts
Recent Indian
experience
36

37. Valuation for takeover Book value
Liabilities
Rs. Cr.
Assets
Rs. Cr.
Share Capital
100 Fixed Assets
300
Reserves
280 Investments
25
Creditors
Provisions
32 Stock
5 Debtors
Misc exp
Total
417 Total
Net Assets (100+280) = 380
10
85
7
417

38. Valuation for takeover Market
Liabilities
Rs. Cr.
Assets
value
Rs. Cr.
Share Capital
100 Fixed Assets
900
Reserves
887 Investments
12
Creditors
22 Stock
Provisions
5 Debtors
Misc exp
Total
1014 Total
Net Assets (100+887) = 987
10
85
7
1014

39. Valuation for takeover Market
value +
Brand
Liabilities
Rs. Cr.
Assets
Rs. Cr.
Share Capital
100 Brand
Reserves
897 Fixed Assets
900
Creditors
22 Investments
12
Provisions
5 Stock
Debtors
Misc exp
Total
1024 Total
Net Assets (100+897) = 997
10
10
85
7
1024

40. Valuation for takeover
Market value + Brand+ adj for streamlining
Rs. Cr
Rs. Cr.
Net asset value (prev. slide)
New Machinery
Less Scrap value of old
997
80
5
Net new machinery
75
Disputed debtors
12
Value offered by purchaser
(89)
908

41. Brand Valuation
(Intellectual Property Assets)
41

42. What is a Brand
The brand is a special intangible that in many
businesses is the most important asset.
Brand has to be registered to hold value.
Some brands have also demonstrated an
astonishing Durability. The world’s most
valuable brand, Coca-Cola, is more than
118 years old.
Majority of the world’s most valuable brands have
been around for more than 60 years. Compare this with the
average life of the Corporation of 25 years.
42

43. Valuation of Firm or Brand?
Firm Level
Firm level approaches measure the brand as a financial asset.
In short, a calculation is made regarding how much the brand
is worth as an intangible asset. i.e.
Mkt cap – (tang.assets +measurable intangible assets)= brand
equity.
Product Level
Compare the price of a no-name or private label product to an
"equivalent" branded product. The difference in price,
assuming all things equal, is due to the brand
Consumer Level
Measure the awareness (recall and recognition) and brand
image (the overall associations that the brand has). Free
association tests and projective techniques are commonly used
to uncover the tangible and intangible attributes, attitudes, and
intentions about a brand. Brands with high levels of awareness
and strong, favorable and unique associations are high equity 43
brands[.

44. IP as a component of IC
44

45. Intellectual
Capital
Human
Capital
“Technological”
Skills and
Competencies
Relational
Capital
“Sociological
” Skills and
Capital
Organisational
Capital
Intellectual
Property
Infrastructure
Capital
45

46. Organisational (structural) capital:
examples of IP
• patents
•
•
•
•
•
•
•
•
copyrights
design rights
trade secrets
trade marks
service marks
trade dress
utility models
plant & seed varieties
46

47. Why Value Intellectual Capital

Measurement of IC - enables a more efficient
management of the company - i.e. to:
 understand where value lies in the company
 have a metric for assessing success and growth
 provide a basis for raising finance or loans

If borrowing can only be secured against
tangible assets, then knowledge-based
companies will be disadvantaged in
investment and growth.
47

48. Brand Value


Brand equity refers to the marketing effects or
outcomes that accrue to a product with its brand
name compared with those that would accrue if
the same product did not have the brand name.
The study of brand equity is increasingly popular
as some marketing researchers have concluded
that brands are one of the most valuable assets
that a company has.
48

49. .
Pa
ha ge 1
nd 8 o
ou f
t
Top Indian Brands of
2013
(Economic Times)

50. Top Global Brands of 2013
Pa
ha ge 1
nd 9 o
ou f
t

51. In the beginning……



Goodwill
(Nestlé’s purchase of Rowntree, Grand
Metropolitan pur. of Pilsbury)
• Did not qualify for lending
• Had to be amortized
• Drained P & L
• Residual assets lower than at takeover
M
i
UK & France left grey areas
80 d
’s
• Reckitt & Colman (UK)put a value on its balance sheet for the
Airwick brand
19
88
First brand independent valuation
• Rank Hovis McDougall (RHM) defensive tactics to thwart
takeover by Goodman Fielder Wattie (GFW).

In 1989 London Stock Exchange endorsed concept
of brand valuation as used by RHM in class test for
51
shareholder approval during take-overs

52. Accounting concerns




Is the intangible asset clearly
identifiable
Does the company hold an
unambiguous title to the asset
Could the intangible asset be sold
separately from the business
Does the intangible give rise to a
“premium” not earned by other
companies?
52

53. Tangibility and Separability: the
Spectrum of Assets
Separable
Wholly tangible
(i.e. machine tool)
Not separable
Highly intangible
(i.e. goodwill)
53

54. Accounting approaches to valuation

Cost based valuation
 historical creation cost - how much did it cost to create?
 current recreation cost - how much would it cost to
recreate an identical intangible?


Market based valuation - evidence from sale or
purchase of similar assets (i.e. individual brands,
branded divisions or whole companies)
Income based valuation looks at the stream of
income attributable to the intangible asset, based
on:
 historical earnings (i.e. multiple of earnings)
 expected future earnings (i.e. discounted cash flow)
54

55. Financial Valuation break-up
Cost Based
Comparables
Financial
Approach
Premium Price
55

56. Cost Based


aggregation of all historic costs incurred
Or
replacement costs required in bringing the brand to its
current state
Brand cost=Dev.Cost + Mktng +Advert.+ Comm. +Others.
Disadvantage
There is NO Direct correlation between financial investment made &
value added.
56

57. Comparables
Compare the price of a no-name or private label product to an
"equivalent" branded product. The difference in price, assuming all
things equal, is due to the brand
&
&


Comparable?
Comparable?
Interesting cross-check
Never be relied on solely for valuing brands
57

58. Premium Price

The value is calculated as the net present value of future
price premiums that a branded product would command
over an unbranded or generic equivalent.
Brand cost=NPV (Target Brand price-Other Brand price)
d
isa
D
n
va
e
ag
t
Primary purpose of many brands ≠ price premium
but rather to secure the highest level of future demand.
The value generation of these brands lies in securing
future volumes rather than securing a premium price.
58

60. 
50/50

Is CID Most Wanted one of the popular TV
shows, a brand?
A : No
B: Yes
C : It is not a product or a service so
it is not a brand
D : It cannot be sold therefore it is
not a brand

62. 62

63. Cost Based
Brand cost=Dev.Cost + Mktng +Advert.+ Comm. +Others.
Description
Cost of formula (20,000 X 62)
Rs. In lacs
Rs. In lacs
12.40
Advertising (2 crores X 3)
600.00
POS Cost
100.00
TOTAL BRAND COST
712.40
Cost Based
estimate = Rs. 712 lacs
63

64. Comparables
Compare the price of a no-name or private label product to an
"equivalent" branded product. The difference in price, assuming all
things equal, is due to the brand
Description
calculation
Difference in price
12 – 10
Difference in monthly units sold 300– 40 (000)
Premium monthly sales
2,60,000 X 2
Premium annual sales
Rs. 5,20,000 X 12
Premium sales for 5 years Rs. 62,40,000 X 5
Rs. /Nos
2
2,60,000
Rs. 5,20,000
Rs. 62,40,000
Rs. 312 lacs
Comparables based
estimate = Rs. 312 lacs
Do you not think that the
sales over the next five years
should be calculated at the
present value?
64

65. Premium Price
Comparables
Calculate the present value (PV) of future cash flows for a justified as
well as a balanced perspective. Rate of PV may be debatable. Let us
take it at 9% being the average expected inflation rate
Brand cost=NPV (Target Brand price-Other Brand price)
Year
1
2
3
4
5
Premium Sales
Rs. In Lacs
62.40
62.40
62.40
62.40
62.40
PV @ 9%
PV X Sales
Rs. In Lacs
1.09
1.19
1.30
1.41
1.54
Total
Premium Price
Estimated Rs. 417.38 lacs
68.02
74.26
81.12
87.98
96.10
417.38
65

66. Interbrand Methodology

67. Income approach
Relief-from-Royalty Method
Step 1
Step 2
Step 3
Step 4
Step 5

Estimate revenues attributable to the IP over its
economic life.

Estimate of an arm's length royalty rate be paid for
the use of comparable IP.

Apply concluded royalty rate to the projected sales
of the brand over its economic life.

Apply an appropriate cash tax charge in each period to
estimate the after tax royalty savings.

Discount to present value the after tax royalty savings
stream.
Easy and common, but can be misleading if not applied carefully

68. Royalty rate determinants









Excess operating profit attributable to the brand
Market comparable royalty rates
The nature of the licence
The strength and importance of this intangible
asset
The geographical scope of the licence
The need for both parties to secure a satisfactory
return
The probable level of continuing sales
The commercial obligations undertaken
The relative negotiating strengths of each party

69. Acquisition / Merger
Impact on the Stock
Exchange

70. Acquisition of Stock (Equity)
Example --
Company A will acquire Company B
with shares of common stock.
All amounts in Rs.
Present earnings (PAT)
Shares outstanding
Earnings per share
Price per share
Price / earnings ratio
Acquirer Co.
Target Co.
2,00,00,000
50,00,000
50,00,000
20,00,000
4.00
2.50
64.00
30.00
16
12

71. Exchange ratio determination
Assuming Target company has accepted offer of
Rs. 35 per share
Merged Company
Total Earnings (Add both company earnings)
Shares outstanding
2,50,00,000
60,93,750
50,00,000 + 10,93,750*
Earnings per share
4.10
Exchange ratio = Rs.35 / Rs.64 = .546875
* New shares from exchange = .546875 x 20,00,000
= 10,93,750

72. Impact on shareholders

The shareholders of Company A will experience
an increase in earnings per share because of
the acquisition [Rs.4.10 post-merger EPS versus
Rs. 4.00 pre-merger EPS].

The shareholders of Company B will experience
a decrease in earnings per share because of
the acquisition [.546875 x Rs.4.10 = Rs.2.24
post-merger EPS versus Rs.2.50 pre-merger
EPS].

73. Exchange ratio determination
Assuming Target company has accepted offer of
Rs. 45 per share
Merged Company
Total Earnings (Add both company earnings)
Shares outstanding
2,50,00,000
64,06,250
50,00,000 + 14,06,250*
Earnings per share
3.90
Exchange ratio = Rs.45 / Rs.64 = .703125
* New shares from exchange = .703125 x 20,00,000
= 14,06,250

74. Impact on shareholders

The shareholders of Company A will
experience a decrease in earnings per share
because of the acquisition [Rs. .90 post-merger
EPS versus Rs. 4.00 pre-merger EPS].

The shareholders of Company B will
experience an increase in earnings per share
because of the acquisition [.703125 x Rs.4.10 =
Rs.2.88 post-merger EPS versus Rs.2.50 premerger EPS].

75. 

Merger decisions
should not be made
without considering
the long-term
consequences.
The possibility of
future earnings
growth may outweigh
the immediate
dilution of earnings.
Expected EPS (Rs.)
What about EPS
With the
merger
Equal
Without the
merger
Time in the Future (years)
Initially, EPS is less with the merger.
Eventually, EPS is greater with the merger.

76. Ratio of exchange of market price.
Market price per share
of the acquiring company
X
Number of shares offered by
the acquiring company for each
share of the acquired company
Market price per share of the acquired company

If the ratio is less than or nearly equal to 1, the
shareholders of the acquired firm are not likely
to have a monetary incentive to accept the
merger offer from the acquiring firm.

77. What is LBO
Leveraged Buy-out is a Company Acquisition Method
 A LBO is a company acquisition method by which
a business can seek to takeover another company
or at least gain a controlling interest in that
company. Special about leveraged buy-outs is that the corporation that is
buying the other business borrows a significant amount of money to pay for
(the majority of) the purchase price (usually over 70% or more of the total
purchase price).


The debt which has been incurred is secured against
the assets of the business being purchased.
Interest payments on the loan will be paid from the
popular
future cash-flow of the acquired company. in the
1980s,

78. LBO Defined




A leveraged buyout (or LBO, or highly-leveraged
transaction (HLT), or "bootstrap" transaction) occurs
when a financial sponsor acquires a controlling interest
in a company's equity and
where a significant percentage of the purchase price is
financed through leverage (borrowing).
The assets of the acquired company are used as
collateral for the borrowed capital, sometimes with
assets of the acquiring company.
The bonds or other paper issued for leveraged buyouts
are commonly considered not to be investment grade
because of the significant risks involved.

79. Figurative representation of LBO

80. Normal targets of LBOs

Low existing debt loads;

A multi-year history of stable and recurring cash flows;

Hard assets (property, plant and equipment, inventory,
receivables) that may be used as collateral for lower cost
secured debt;

The potential for new management to make operational
or other improvements to the firm to boost cash flows;

Market conditions and perceptions that depress the
valuation or stock price.

81. Rationale


The use of debt increases (leverages) the
financial return to the private equity sponsor. As
the debt in an LBO has a relatively fixed, albeit
high, cost of capital, any returns in excess of this
cost of capital flow through to the equity.
The tax shield of the acquisition debt.

82. Advantages of LBO
1.
2.
3.
4.
5.
Low capital or cash requirement for the acquiring entity
Synergy gains, by expanding operations outside own industry or
business,
Efficiency gains by eliminating the value-destroying effects of
excessive diversification,
Improved Leadership and Management. Takeovers weed out or
discipline rogue managers.
Leveraging: as the debt ratio increases, the equity portion of the
acquisition financing shrinks to a level at which a private equity firm
can acquire a company by putting up anywhere from 20-40% of the
total purchase price.

83. Weakness of LBO
1.
2.
3.
4.
5.
6.
Exploiting wealth of third party
Interest payments are tax deductible so Government looses
on revenue
Risk of management and shareholder confrontation will impair
the success of the LBO.
Risk is effectively transferred to the Financer who has only
interest compensation for the risk; making the equation unfair.
Most of the LBOs were for asset stripping which is frowned
upon by mature corporate.
Structuring a LBO document for a financer is difficult in the
Indian Legal Environment.

84. Thank you