DEMYSTIFYING MERGERS &

ACQUISITIONS

presented by :SIDDHANT BAHALB. COM (M), 3RD YEAR,ROLL NO. – 58, ROOM NO. – 06SESSION – 2011-2014SPECIALIZATION IN FINANCEST. XAVIER’S COLLEGE, KOLKATA

Under the Mentorship & Tutelage of :

PROFESSOR SUBIR SRIMANIHEAD OF DEPARTMENT

ACCOUNTING & FINANCEDEPARTMENT OF COMMERCE

ST. XAVIER’S COLLEGE, KOLKATA

OBJECTIVE OF THE STUDY –

> To unearth the hidden facets of the topic

> To depict the impact of strategies on the decision

making

EXPLORATION TECHNIQUE -

> Primary Data Collection> Secondary Data Collection

> Case Studies emphasizing on different strategies

REASON FOR RESEARCH –

> To be an expert in this branch of investing banking> Demystify for self future

planning > Lack of reference material

from the point of view of “STRATEGIES” & “PHASES”

LIMITATIONS – > Many topics still left to be

covered> Cases are explained from a

strategic point of view, valuations are not covered> Taxation is ignored due to limited purview of the topic

> Detailed analysis of EU is not brought out

Mergers and acquisitions are manifestations of growth process through an inorganic route. While mergers can be defined to mean unification of two players into a single entity, acquisitions are situations where one player buys out the other to combine the bought entity with itself. The techniques of growth through an inorganic route :

INTRODUCTION

MERGER

ACQUISITION

DE-MERGE

R

THE PROCESS IN BRIEF -

COMPETITIVE ANALYSIS

SEARCH & SCREEN

STRATEGY DEVELOPMENT

FINANCIAL EVALUATION NEGOTIATION

M&A TRANSACTION = SHAREHOLDER’S VALUE ENHANCER

HOW?

VALUE CAPTURE

•A long term phenomenon which results from the synergy generated from a transaction.•It may be achieved by way of functional skill or management skill transfers.

VALUE CREAT

ION

•It is a one-time phenomenon.•The shareholders of the acquiring company gain the value of the existing shareholders of the acquired company.

VALUE CAPTURE

STRATEGY

STRATEGIES

GROWTH

SYNERGY

OPERATING SYNERGY

FINANCIAL SYNERGY

DIVERSIFICATION

OTHER ECONOMIC MOTIVES

HUBRIS HYPOTHESI

S

OTHER MOTIVES

GR

OW

TH

OPTIONS OF GROWTH

INTERNAL GROWTHALSO KNOWN AS ORGANIC

GROWTH

EXTERNAL GROWTHALSO KNOWN AS INORGANIC

GROWTH

SY

NE

RG

Y THE SYNERGY EQUATION

NAV = VAB – [ VA + VB ] – P – E

where:VAB = the combined value of the two firmsVA = the value of AVB = the value of BP = premium paid for BE = expenses of the acquisition process

SY

NE

RG

YSYNERGY

GAINS DUE TO FISSION

REVERSE SYNERGY

TYPES OF SYNERGY

OPERATING SYNERGY

FINANCIAL SYNERGY

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Diversification means growing outside a company’s current industry category.

“Portfolio” Management of Business Units -Expansion through the acquisition of a number of firms, is an attempt to achieve some of the benefits that investors receive by diversifying their portfolio of assets. However, when this strategy is applied to capital assets and whole corporations, it loses some of its appeal.

Having a diverse corporation that spans a number of different business areas may help facilitate dividend stability.

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Putting All One’s Eggs in One Basket.

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Diversification to Enter More Profitable IndustriesA major reason for management to opt for diversified expansion is its desire to enter industries that are more profitable.

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NFinancial Benefits of DiversificationOne possible area of benefits of diversification that has been cited is the coinsurance effect. This occurs when firms with imperfectly correlated earnings combine and derive a combined earnings stream that is less volatile than either of the individual firms’ earnings stream. If the covariance between earnings of two potential merger candidates is negative, there might be an opportunity to derive coinsurance benefits from a combination of such firms. What the merger partners have to determine is if these coinsurance ”benefits” truly provide benefits to shareholders beyond what they can achieve on their own.

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CON

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IC M

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HORIZONTAL

INTEGRATION

• Horizontal integration refers to the increase in market share and market power that results from acquisitions and mergers of rivals.

VERTICAL

INTEGRATION

• Vertical integration involves the acquisition of firms that are closer to the source of supply or to the ultimate consumer. The vertical combination is motivated by a movement toward the consumer.

HU

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YPO

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F TA

KEO

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S Investopedia explains 'Hubris' as characteristic which may be developed after a person encounters a period of success. A manager might start making business decisions without fully thinking through the consequences, or a trader may begin taking on excessive risk which may bring about their own downfall.The hubris hypothesis implies that managers seek to acquire firms for their own personal motives and that the pure economic gains to the acquiring firm are not the sole motivation or even the primary motivation in the acquisition.

Winner’s Curse Hypothesis of TakeoversThe winner’s curse of takeovers is the ironic hypothesis that states

that bidders who overestimate the value of a target will most likely win a contest.

OTHER MOTIVES

Improved Manageme

nt

Improved R&D

Improved Distributio

n

Tax Motives

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KEY NOTATIONS EXPLAINED

Leverage Buyouts and related terminology

Value v/s Valuation Valuation of a Privately held Companies Merger Arbitrage Short Form Merger Freeze out and the Treatment of Minority

Shareholders Reverse Merger

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S A leveraged buyout is a financing technique, i.e., it is the use of debt to purchase the stock of a corporation, and it frequently involves taking a public company private.

The incentive to go private is greatest when management and the board believe the firm is undervalued. Moreover, public companies are more likely to go private if the cost of governance is high, the need for liquidity is low, and the potential loss of control is high.

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S•An MBO is a type of LBO that occurs when the management of a company decides it wants to take its publicly held company, or a division of the company, private.

Management Buyouts

• Secured debt, which is sometimes called asset-based lending, may contain two subcategories of debt: senior debt and intermediate-term debt.

• Unsecured debt, which is sometimes known as subordinated debt and junior subordinated debt, lacks the protection of secured debt, but generally carries a higher return to offset this additional risk.

Financing for Leverage Buyouts

•Post completion of the deal, the capital structure of a company taken private in an LBO is usually different from its structure before the buyout.•After the buyout, the firm is very highly leveraged.

Capital Structures of

LBOs

Types of LBO Risk

Reverse LBOs

• Business risk • Interest rate risk

• A reverse LBO occurs when a company goes private in an LBO only to be taken public again at a later date.

VA

LUE

VER

SUS

VALU

ATIO

NVALUE GAINS FROM MERGER

Combined value > (Value of acquirer + Standalone value of target)

The difference between the combined value and the sum of the values of individual companies is usually attributed to synergy.

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

VA = Rs 100VB = Rs 50VAB = Rs175

Synergy = VAB – (VA + VB) = 25

VA

LUE

VER

SUS

VALU

ATIO

N

VALUATION TECHNIQUE

EARNING BASED VALUATION

MARKET BASED VALUATION

ASSET BASED VALUATION

DISCOUNTED CASH FLOW / FREE CASH FLOW

COST TO CREATE APPROACH

CAPITALIZED EARNING METHOD

CHOP – SHOP METHOD

MARKET CAPITALIZATION OF LISTED COMPANIES

MARKET MULTIPLES OF COMPARABLE COMPANIES FOR UNLISTED COMPANIES

NET ADJUSTED ASSET VALUE OR ECONOMIC BOOK VALUE

INTANGIBLE ASSET VALUATION

LIQUIDATION VALUE

VA

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N Case Study – Valuation AnalysisX & Y, software companies, former listed and latter unlisted; decided to merge to benefit from marketing. X was merging for the high growth potential of Y, and Y was for the experience of X, a listed entity. SWAP RATIO was fixed at 1:1.

•Valuation based on book value net asset value would not be appropriate for X and Y since they are in the knowledge business.• X and Y were valued on the basis of expected earnings & market multiple.•While arriving at a valuation based on expected earnings, a higher growth rate was considered for Y, it being on the growth stage of the business life cycle while a lower rate was considered for X, it being in the mature stage and considering past growth. •Different discount factors were considered for X and Y, based on their cost of capital, fund raising capabilities and debt-equity ratios.•While arriving at a market based valuation, the market capitalization was used for X. Since X had a significant stake in Z, another listed company, the market capitalization of Z had to be removed.•Several comparable companies for Y had to be identified, and a composite of their market multiples had to be estimated as a surrogate measure to arrive at Y’s likely market capitalization, as if it were listed. This value had to be discounted to remove the listing premium since the surrogate measure was estimated from listed companies.•A weighted average value was calculated after allotting a higher weight for market based method for X & a higher weight for earnings based method for Y. The final values for X and Y were almost equal and hence the 1:1 ratio was decided.

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With respect to M&A, arbitragers purchase stock of companies that may be taken over in the hope of getting a takeover premium when the deal closes. This is referred to as risk arbitrage, as purchasers of shares of targets cannot be certain the deal will be completed. They have evaluated the probability of completion and pursue deals with a sufficiently high probability.

ARBITRAGE REFERS TO THE BUYING OF AN ASSET IN ONE MARKET AND SELLING IT IN ANOTHER.

SHO

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•Stockholder approval process is not necessary•Stockholder approval may be bypassed, by the management who is advocating the merger.•Board of directors simply approves the merger by a resolution

•Minority Shareholders are “FROZEN OUT” when the majority have approved the deal. •A holdout problem needs to be prevented, which may occur when a minority attempts to hold up the completion of a transaction unless they receive a satisfactory compensation.

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RS A reverse merger is a merger in which a private company may go public

by merging with an already public company that often is inactive or a corporate shell. The combined company may then choose to issue securities and may not have to incur all of the costs and scrutiny that normally would be associated with an initial public offering. The private-turned-public company then has greatly enhanced liquidity for its equity.

A REVERSE MERGER SAVES TIME

Volume of Reverse Mergers

MERGERS & ACQUISITIONS

PROCESS

Phase 1 – Building the

business plan

Phase 2 – Building the

Merger-Acquisition

Implementation Plan

Phase 3 – The Search Process

Phase 4 - Screening the Initial Search

Results

Phase 5 – First Contact

Phase 6 – Negotiation

Phase 7 – Developing

the Integration

Plan

Phase 8 – Closing

Phase 9 - Implementing Post-closing Integration

Phase 10 - Conducting a Post-closing Evaluation

THE 10 PHASES TO MERGE & ACQUIRE ARE -

CASE STUDIES

EMAMI’s Acquisition of ZANDU in 2008

29 June 2008:

>Emami bought 23.6% stake in Zandu >Deal value : Rs 130crores

>Paid Rs 6900 per share through off market deals with the Vadiyas , one of

the promoter groups of Zandu >Emami Already having 3.7% stake

>Total holding in Zandu 27.5%

2 June 2008>Open offer was made by emami to acquire upto 20 % stake in Zandu

>Open offer price : Rs 7315 per share >Dispute initiated with Girish Parikh , one of the promoter who holds 22 %

in the Zandu >Zandu’s allegation “The purchase of shares from the Vaidya family in two tranches, indicated that Emami had

already decided to acquire more than 15 per cent, hence violating the SEBI

Takeover Regulations (1997) >Matter moved to SEBI who

transferred it to CLB>CLB held back open offer by emami

till further decision12 Sept 2008

>SEBI clears open offer for Zandu >Emami doubled open offer price for

Zandu pharma from Rs 7,315 to Rs 15,000

>Open offer commenced on September 26 , 2008 and closed on

October 15, 200816 Oct 2008

>Parikh gives in , Emami wins Zandu >Sold 18.8 pc stake at Rs 16,500 a

share >Emami got controlling stake

>Deal value : Rs 242crores>Deal includes non competing fee of

Rs 1500 per share >Bought Rs 54 crore worth of Zandu

shares from the open market >Post the open offer Emami controls

66 % stake in company >Emami payed close to Rs

700croresfor Zandu >Zandu became Emami’s fully owned

subsidiary

1 Dec 2008>Made Zandu pharma its subsidiary

>Emami plans to merge Zandu surfaced

>Planning to raise $50m through private equity funding by selling 15%

of equity >Planning to hive off Zandu chemicals

as it is making loss

GRASIM-ULTRATECH Renovation

: Trustline Research; 16/11/2009

Why did the restructuring take place? Because it was a WIN-WIN Proposition.Preserves the essential strengths and benefits of the current structureoContinuation of Grasim’s parentageoEconomic interest of shareholders remains the sameoGrasim will continue to consolidate the cement business results in its accountsEnhances financial flexibility in both of the key businesses of Grasim - VSF and Cement – to undertake significant growth plansCreates a pure-play cement entityoGrasim shareholders given additional shares to participate directlyIf the consolidation of cement businesses materializes, it will align interests of all stakeholders

HDFC BANKS’ Appetite for CENTURION BANK OF PUNJAB

Increase in scale of operations

Increase in geography

Management bandwidth

Potential of Business synergy and cultural fit

HDFC’s Brand leverage and increased utilization

of CBOP Branches

CBOP’s SME focus complement HDFC’s

Corporate focusREASONS

FOR MERGER

SEPTEMBER,

2007

SWAP

RATIO

SWAP

VALUE

APRIL,

2010

VALUE

APPRECIATION

HDFC 1433 1 1433 1984 38.45%

CBOP 41 29 1189 1984 66.86%

INDEX 5001 1 5001 5250 4.98%

Gains to Shareholders –

EUROPEAN UNION - AN INSIGHT

SUCCESS OF EUROPEAN

UNION

CONCLUSIONThe report is brisk in its approach and does not go beyond what is absolutely

relevant. Mergers and acquisitions have always been around, forever changing with

eternally new dynamics. The strategies are critically explained. We should also

recognize some cold hard facts about mergers and acquisitions:

•Synergies projected for M & A's are not achieved in 70% of cases.

• Just 23% of all M & A's will earn their cost of capital.

• In the first six months of a merger, productivity may fall by as much as 50%.

•The average financial performance of a newly merged company is graded as C -

by the respective Managers.

• In acquired companies, 47% of the executives will leave the first year and 75%

will leave within the first three years of the merger.

THANK YOU