Download - Mergers and Acquisitions in Tea Industry
MERGERS AND ACQUISITIONS IN TEA INDUSTRY: A CASE STUDY
A Dissertation submitted in partial fulfillment of
the requirements for the Degree of Masters in Finance and Investment at the
University of Nottingham September 2007.
BY
SHASHANK AGARWAL STUDENT ID: 4055919
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ACKNOWLEDGEMENT
I w o u l d l i k e t o t h a n k e v e r y o n e w h o h e l p e d m e i n t h e c o m p i l i n g o f
m y d i s s e r t a t i o n , f r o m i n i t i a l r e s e a r c h t o f i n a l d o c u m e n t a t i o n . I
s p e c i a l l y w a n t t o t h a n k M s . K u a s i r i n i k a n N o n g n o o c h w h o
s u p e r v i s e d t h i s s t u d y a n d g a v e v a l u a b l e f e e db a c k a n d a d v i c e
t h r o u g h o u t . H e r a s s i s t a n c e i s g r e a t l y a p p r e c i a t e d .
F u r t h e r t h a n k s t o m y p a r e n t s a n d m y f a m i l y f o r t h e i r u n l i m i t e d
s u p p o r t d u r i n g m y s t u d y i n U . K .
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ABSTRACT
This dissertation is aimed at finding motives and assessing the consequences of
mergers and acquisitions, taking Tata Tea’s acquisition of Tetley into
consideration. It overviews a vast amount of theoretical literature on mergers and
acquisitions and presents empirical literature findings on company’s post-merger
financial performance. Case study section of the dissertation considers the history
of Tata Tea Ltd. for engaging in M&A activities and measures the consequences of
the activity by applying accounting and empirical financial approaches.
Quantitative data is obtained from both online and published resources. The
findings from the study are:
Mergers and acquisitions contribute to increase in net sales revenue.
Their impact on market share can either be neutral or positive.
Quantitative data is taken from company’s annual reports, business research
companies’ archives and financial websites. The findings from the study are
mergers and acquisition’s can either have a positive or negative impact on
financial performance.
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CONTENTS
1. INTRODUCTION .................................................................... 6
1.1 BACKGROUND ON MERGERS AND ACQUISITIONS ..................................... 7
1.1.1. Definition of Mergers and Acquisitions ........................................................... 7
1.1.2. Types of Mergers and Acquisitions .................................................................. 9
2. AIM OF THE STUDY ............................................................. 12
2.1. RESEARCH APPROACHES ................................................................................ 12
2.2. PLAN ..................................................................................................................... 13
3. LITERATURE REVIEW ......................................................... 14
3.1. THEORETICAL LITERATURE: THE REASONS AND MOTIVES BEHIND
MERGERS AND ACQUISITION ............................................................................... 14
3.2. THEORETICAL LITERATURE: SUCCESS AND FAILURES OF MERGERS
AND ACQUISITION ................................................................................................... 20
3.3. THEORETICAL LITERATURE: CROSS-BORDER MERGERS &
ACQUSITIONS ............................................................................................................ 25
4. EMPIRICAL EVIDENCE: CONSEQUENCES OF
ENGAGING IN MERGER AND ACQUISITION ...................... 27
4.1. EVENT STUDY .................................................................................................... 27
4.2. ACCOUNTING STUDY ....................................................................................... 30
4.3. SURVEY OF EXECUTIVES ................................................................................ 34
4.4. CLINICAL STUDY............................................................................................... 36
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5. RESEARCH METHODOLOGY ............................................. 39
5.1. ACCOUNTING METHODOLOGY: THE BENCHMARK APPROACH .......... 39
6. CASE STUDY .......................................................................... 42
6.1. AN OVERVIEW OF TATA TEA LIMITED ....................................................... 42
6.2. AN OVERVIEW OF TETLEY ............................................................................. 42
6.3. THE HISTORY OF TATA TEA’S MERGER AND ACQUISITION DEALS ... 43
6.4. BLENDING WITH PERFECTION ...................................................................... 45
6.5. THE CHALLENGES ............................................................................................. 47
6.6. FLAVOUR OF SYNERGIES................................................................................ 49
6.7. GLOBAL SCENARIO .......................................................................................... 55
6.8. FINANCIAL ANALYSIS OF TATA-TEA PRE-ACQUISITION ....................... 61
6.9. LEVERAGED BUY-OUT ..................................................................................... 65
7. CONSEQUENCES OF TATA TEA’S ACQUISITIONS OF
TETLEY ....................................................................................... 67
7.1. NET SALES REVENUE ....................................................................................... 67
7.2. POST-MERGER FINANCIAL PERFORMANCE ............................................... 69
8. CONCLUSION ........................................................................ 73
REFERENCES ............................................................................. 76
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1. INTRODUCTION
Earlier, after a pitched battle among the MNC's in the domestic arena, not many Indian
tea manufacturing companies thought of going global. Devour competitors and destroy
competition - the mantra that the global conglomerates had been chanting so far, had not
gone well with the Indian counterparts.
But fortunately, that doesn’t remain the prerogative anymore. The war-averse domestic
companies are shedding their inhibitions. The roles have undoubtly changed. And, after
fighting in out in the global commodities arena, it is time now for a global teacup.
Taking a plunge in the global tea war in the year 2000 was India’s corporate tea giant
Tata Tea. Though it was not an easy decision to make, that to when the competitor was
no less than a stature of Unilever, a global food and beverage behemoth, but the Tata Tea
had little choice - shape up or be swapped. It chose the former. And, what else could have
been a better vehicle than Tetley for Tata tea to take on the might of global tea giants like
Lever and Hillsdown.
The expansion took place through the acquisition of another tea giant from the UK-
Tetley. Tata tea finally tasted victory on March 10, 2000 when it bought Tetley for a
staggering INR 2,135 crore (305 million sterling). Such a deal had never been heard or
seen before in the Indian Corporate world. What makes this deal special is the fact that it
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is the first ever LBO (Leveraged Buy Out) by any Indian company. In fact, this also
happened to be the largest ever cross-border acquisition by an Indian company.
1.1 BACKGROUND ON MERGERS AND ACQUISITIONS
1.1.1. Definition of Mergers and Acquisitions
Mergers and Acquisitions have always played a vital role in corporate history, ranging
from ‘greed is good’ corporate raiders buying companies in a hostile manner and
breaking them apart, to today’s trend to use mergers and acquisition for external and
industry consolidation.( Sherman & Hart, 2006)
The terms mergers and acquisition are often used interchangeably but it is important to
understand the differences between the two.
In the academic literature, there are number of authors, who define merger, acquisition
and takeover differently. According to Sudarsanam (1995), a merger takes place when
two or more corporations come together to combine and share their resources to achieve
common objectives. The shareholders of the combining firms often remain as joint
owners of the combined entity. But according to Sherman and Hart (2006), a merger is a
combination of two or more companies in which the assets and liabilities of the selling
firms are absorbed by the buying firm. According to Gaughan (2002), a merger is a
process in which two corporations combines and only one survives and the merged
corporation ceases to exist. Sometimes there is a combination of two companies where
both the companies cease to exist and an entirely new company is created.
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An acquisition on the other hand, is the purchase of an asset such as a plant, a division or
an entire company. Sudarsanam (1995) defines acquisition as an ‘arms- length deal’,
where one company purchases the shares of another company and the acquired company
is no longer the owner of the firm.
The term ‘takeover’ is sometimes used to refer a hostile situation. According to Gaughan
(2002), this happens when one company tried to acquire another company against the will
of the company’s management. But according to Sudarsanam (1995), a takeover is
similar to an acquisition and also implies that the acquirer is much larger than the
acquired.
According to Gaughan (2002), mergers and acquisition are friendly transactions in which
the senior management of the companies negotiate the terms of the deal and the terms are
then put in front of the shareholders of the target company for their approval. Whereas in
a takeover, a different set of communication takes place between the target and the
bidder, which involves att6orney and courts. Bidders here try to appeal directly to the
shareholders often against the recommendations of the management.
According to Sudarsanam (1995), the differences between merging and acquiring are
very important to consider valuing, negotiating and structuring the client’s transactions.
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‘In line with common practice’ ( Chiplin and Wright, 1988) , terms ‘mergers’ ,
‘acquisitions’ and ‘takeovers’ will be used synonymously in this dissertation. According
to Sherman and Hart (2006), at the end, the differences in the meaning may not really
matter since the result of these processes is often the same i.e. two companies that had
separate ownership are operating under the same roof, usually to obtain some strategic
and financial objective.
1.1.2. Types of Mergers and Acquisitions
Brealey and Myers (2004) and Gaughan (2002) in respect with the economic theory
classify mergers and acquisition into three categories:
Horizontal Merger and Acquisitions
This is the combination of two corporations in similar lines of business or between two
competitors.
The main reason for merging and acquiring similar business is with the aim to obtain
synergy between the two business units. Apart from this, other reasons for horizontal
M&A’s are to increase the market power, exploit economies of scale, to diversify through
separate markets and provide different services.
The level competition in an industry is affected by the increased horizontal M&A’s and
according to the economic theory consumer’s benefit from the increased competition.
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Some of the examples of horizontal M & A are JP Morgan and Chase Bank and
Vodafone’s acquisition of Mannesmann.
Vertical Merger and Acquisitions
These are combination between companies in same lines of business but different aspects
of production. Vertical M&A may be of two types:
When a producer acquires a supplier of the raw material in the chain of
production, with the aim of reducing cost of production, it is called backward
vertical integration.
When a company buys its vendor, in the direction of its consumer to reduce
marketing and delivering costs, it is called a forward M&A.
Some examples of vertical M&A are acquisition of Kalon Group by Total and Walt
Disney’s acquisition of ABC television network
Conglomerate Merger and Acquisitions
This is a combination of companies with different or unrelated fields of business. These
companies neither are related nor they are competitors The main motives for
conglomerate M&A are efficient capital allocation and the reluctance to distribute cash
flows to the company’s shareholders Companies also seek diversification of risks and
entry to a new emerging market through this type of acquisition (Marks and Mirvis ,
1998)
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Some examples of conglomerate M&A are acquisition of General Foods by Philip Morris
and the acquisition of NCR by AT&T’s.
Cartwright and Cooper (1992) make a distinction of one more category called the
concentric merger, which is acquisition of the dissimilar but associated field of business
in which the buying company looks forward to expansion.
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2. AIM OF THE STUDY
My research is focused on one of the major manufactures of tea – Tata Tea Limited. The
Tea Industry has been experiencing an increasing market but at a declining rate. India the
largest producer of tea has been experiencing stiff competition from countries like Sri
Lanka and Kenya and the decline in demand of tea has also been a major problem. In my
dissertation I argue that M&A’s had a significant impact on the company’s market share,
net sales revenue and financial performance.
The research questions I posed are as follows:
1) What were the main motives of Tata Tea’s acquisition of Tetley? Did Tata Tea achieve
its goal?
2) What were the consequences of Tata Tea’s acquisition of Tetley? How did this activity
affect the companies’ market share, net sales revenue and financial performance?
2.1. RESEARCH APPROACHES
In order to answer these questions, I decided to use both qualitative and quantitative
approaches.
A qualitative approach is important for answering the first question as it helps in knowing
the in-depth answers, identifying the dimensions of the problem, drawing assumptions
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and understanding motivations. Therefore, I will be using quantitative research to collect
relevant data from online and printed publications, such as scientific journals, research
papers, news articles and books with the purpose of outlining the pre-merger motives of
the companies.
A quantitative approach is necessary for answering the main part of the second question
as statistical data should be obtained. Hence I would use quantitative methodology –
accounting methodology, which is a branch of empirical financial analysis, with the aim
of providing estimates of the companies post merger financial performance.
2.2. PLAN
The remaining part of my dissertation is as following:
The next section is ‘Literature Review’, which overviews the broad theoretical and
empirical literature on motives and consequences of Mergers and Acquisitions. The
quantitative methodology which was applied in my analysis is explained in ‘Research
Methodology’ section. Then the history, motives and consequences of Tata Tea’s
acquisition of Tetley are investigated in ‘Case Study’ section. Finally, conclusion section
briefly overviews the findings and concludes the dissertation.
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3. LITERATURE REVIEW
3.1. THEORETICAL LITERATURE: THE REASONS AND
MOTIVES BEHIND MERGERS AND ACQUISITION
There are multiple reasons for engaging in merger and acquisition activity. Globalisation,
economic development, technical innovation, etc.. All these factors contribute to the
growing popularity of M&A.
I decided to study each of the motives in detail in order to outline the theoretical
implications of M&A and strategic alliances activity.
Growth
Growth being the reason behind M&A seems to be a straightforward statement.
Companies try to strengthen corporate growth strategies. The main objective is to
broaden product lines and increase the market share and finally stabilise the financial
position of a company. Whether growth refers to revenue growth or to growth in
profitability is the main difference, and the two may be very different.
Companies can grow in two ways
Through internal expansion or organic growth – This process of growth is slow
and presents its own risk.
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Through M&A’s – This process can allow companies to capture the opportunities
available in the market more quickly. M&A’s enables a company to acquire a
running business rather than build up a new one. (Gaughan, 2002)
Synergy
Synergies are created when the value of the combined firms involved in M&A’s process
is more than the sum of their pre-acquisition. The concept of synergy is used to refer to
the economies of scale at the firm level. Synergy is also said to arise from intangible
assets such as goodwill, knowledge and organisational arrangements in an industry.
(Thompson, 1978)
Categories of Synergy: Synergies are mainly classified as two types
Operating synergy: This is achieved by the combination of companies that result in
operating economies from a reduction in costs. These cost reduction may result from
economies of scale. (Gaughan,2002) This is an economic term that refers to the reduction
in per unit costs that result from an increase in the size or scale of companies operations.
Cost advantages can also be achieved from the expansion of the scope of the company’s
operations. (Kinnie, 1999) Economies of scope result from the ability to use combining
inputs or production facilities and offer a wide range of products and services.
Diseconomies of scale may also arise due to higher cost associated with the management
of the organisation and other problems associated with coordinating a larger scale
operation like culture divergence, management style and structure, etc.
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Revenue sharing synergy: These synergies are created when it increase the ability of the
combined firm to generate and increase revenues. If a corporation has an increase in its
revenue after the merger, then perhaps synergies explain the gain. (Gaughan, 2002)
Among the two types of synergy, revenue sharing synergy is more difficult to achieve. It
is easier to implement cost-cutting techniques and to find areas of overlapping business
that can be eliminated, thereby reducing costs. It is often more difficult that the
combination of two companies generates higher revenues than they would have as two
separate companies. This is one of the main challenges of M&A’s, and many do not
succeed in their attempt to increase revenue growth in a way that more than offsets the
costs of the deal. (Gaughan, 2002)
There are also other sources of synergy such as:
Financial Synergy: When a company with better financial position with less profit
making opportunities merges with a company with has certain growth opportunities but
has insufficient access to capital, financial synergy is created and the above problem is
alleviated. This can be seen with the merger of small companies by a large corporation.
The only vital point is that the target actually has profit-making tools. Financial synergies
are more focussed and include tax benefits, diversification, a higher debt capacity and use
for excess cash. (Damodaran , 1994)
This synergy is seen in the merger of private businesses with the public ones. There
might be another view point taking financial in the form of hostile takeovers. But
according to Bhide (1993) hostile takeovers are not followed by significant change in the
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level of the capital investments of acquired firms. So, the standard point of view still
focuses on the improvement of the performance rather than destruction of the target firm.
Tax based synergy: Sometimes a combination may be fruitful for a buyer when it is
successful in exploring the unexploited tax benefits of the target. Tax benefits arise when
targets assets book value is lower than its market value. Then the company acquiring this
target has the advantage of showing assets it buys in the balance sheet at the market value
which is lower than the book value. Also for example the net operating losses (NOL’s)
may be transferred to a buyer which may enable the target to offset profits on which it
had to otherwise pay taxes. Other sources of tax based synergies may be depreciated tax
shields, which may come from a step up in the basis of the target assets following an
acquisition.(Gaughan, 2002) However , tax benefits may not be the same in all the
countries and the tax legislation might curb the merger process for such a motive.
Many authors have criticized the concept of synergies over the years According to
Kitching (1967) , operational and managerial synergies seem to be vague concepts of
merger activity. Also according to Trautwein (1990), financial synergy cannot be
achieved in an efficient capital market. Also Rumlet (1982) claimed that there was no
evidence for a lower systematic risk or perfect internal capital market.
Improved management: It is reasonable motive for acquisition by large companies with
high level of management expertise when the target is a company that lacks such
resources. It takes a greater degree of managerial sophistication control a larger
organisation than a small business. A company which is efficient may acquire a company
which is relatively inefficient. (Copeland, Weston & Shastri, 2005) This process
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improves the efficiency in many ways. Inefficient managers may be replaced with better
ones and the threat of being a target, the managers is forced to improve the efficiency.
Also the salary of the managers is related with the size of the company. (Martin and
Mcconnel, 1991). Also mergers are a simple way to eliminate inefficiency as the
managers would never demote themselves and shareholders don’t have direct access to
those who run the firm and how. (Brealey and Myers, 2004)
Hubris hypothesis
The role that hubris or managerial pride plays in M&A’s for their own personal reasons
rather than the economic gains of the company they are managing is questionable. This
hypothesis was first proposed by Roll (1986) and it implies that managers commit errors
of over-optimism in evaluating mergers at the cost of the company. (Gaughan, 2002)
Managers might unintentionally and randomly make errors also in a merger process
which leads to excessive premiums paid for the target companies. On the other hand
managers who are rational may make valuation mistakes in spite of the gains from the
acquisition and may also deliberately overpay for target companies at the expense of the
shareholders (Seth, 2000) For example mangers who have an ‘empire building ambition’,
are obsessed with power and want to expand their control beyond reasonable boundaries.
Diversification
Diversification is said to be one of the most important motive for M&A activity.
According to Thompson (1978), a company which has excess of cash or credit is
influenced by executive desires to growth rather than simply distributing excess resources
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to the shareholder INR. Also conglomerate acquisition allows companies to diversify
their risk and exposure to volatile industry segments by acquiring firms in different
industries
There are many advantages of diversification. It helps to increase the value of the
company through economies of scale , scope or market power(Hitt) Geographical
diversification gives a company access to bigger markets and a state of depression is not
likely to occur at all places at the same time and to the same extent.
However, there are arguments put against diversification. Berger and Ofek (1995), found
following a conglomerate acquisition, firms value drops by 13 % - 15% on an average.
Also Brealey and Myers (2004), argue that diversification is easier and cheaper for the
shareholders than for the corporation and investors don’t pay premiums for diversified
firms.
Economies of scale and scope
Achieving these economies of scale in the natural goal of horizontal mergers It provides
the advantage of decrease in average cost of production due to increase in scale of
production. Low costs is important for company’s profitability, success and
survival.(Brealey and Myers,2004) Operating economies can also be achieved by
combining firms at different stages of an industry which can lead to better coordination at
different levels.( Alchian, 1998)
Economies of scope imply to savings of production attributable to an increase in a variety
of goods produced. According to Dymski (1999), there are significant gains in cost
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efficiency for targets consistent with gains from economies of scope and also find
significant improvements in efficiency for acquiring firms.
Economies of scale and scope may arise in M&A process through the consolidation of
marketing and sales force, improving customer base and sharing technological
innovations within the newly created company. Reduced competition and larger markets
allow greater pricing power which in turn allows higher sales growth and increased
profits. (Damodaran, 1999)
Deregulation
It is one of the important factors for the increase in the number of mergers and
acquisitions in a specific industry. Opportunities for companies are created as deals
which were previously prevented are made possible through deregulation.
3.2. THEORETICAL LITERATURE: SUCCESS AND FAILURES OF
MERGERS AND ACQUISITION
When two organizations combine together, they want to achieve something together what
they couldn’t separately. The concept of synergy is very alluring and leads to large
investments and millions of job working to achieve the goal. (Marks and Mirvis , 1998)
Whether a merger has been a success and what is the mode of success is difficult to
assess. Estimates show that about 80% of the mergers don’t meet their financial goals,
producing higher than expected cost and lower than expected returns (Marks and Mirvis ,
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1998) and that about 50% of the mergers are failures.( Nahavandi and Malekzadek ,
1993)
A crucial period which determines the success or failure of a merger is the way in which
the transition is handled in the first few months, in which the employees of the target
organization will assess the corporate culture of the bidder and compare it with their
previous culture and mark it. (Cartwright and Cooper, 1991)
According to Porter (1987), when companies in the same line of business merge together
(horizontal M&A) , they have a better success rate than companies coming together in
different fields of business, the main reasons being economies of scale, expertise and
ease of knowledge transfer.
The prime reason for the significant amount of failure lies on the companies attempt to
combine their different identities into a single one. Each merger differs from each other,
but they can be distinguished by some general rules which highlight the mistakes
companies made and indicate success factoINR When an acquirer decides to merge, it is
guided on an idea of corporate match but not a strategic objective. According to KPMG
2003 , companies which merge mainly because of corporate fit rather than strategic
objectives are more likely to be confronted with the problem of conformity
disappearance. Also companies pay much attention to cost reduction rather than paying
attention to the development of the company as a whole. In addition there is a problem of
inefficient communication (Carr, Elton, Rovit & Vestring, 2004).Efficient
communication from the direction of management can give an opportunity not only to
retain key employees but also to attract the new ones.
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Sudarsanam (1995) and Damodaran(2001) , stated the following reasons for the failure of
many mergers
Flawed strategy
The strategic plans adopted in a merger play an important role post-merger. A business
strategy which is not sufficient to meet the expected plan will lead to a company being
acquired which may have a superficial strategic fit. Also a good strategic analysis pre-
merger is important but it is not a surety to the success of the merger.
Clarity in the objective
The objective of the merger should be clear, that is whether the acquisition has a motive
of value creation or it is expanding the market share, is important in order to achieve the
ultimate goal of the organization. The KPMG (2005) survey found that the respondents
had no clear idea about the motive of the merger and different views about it.
No pre and post integration planning
The integration of the two companies must be tailored to the target and the aim of the
merger should be explained and then preserved to avoid any confusion which could lead
to bigger problems. Companies often are not able to keep their credibility up to the mark
and have to face problem during the integration process, especially from the various
departments of the target company. Also the power struggles can be noticed between the
management of the two companies post-acquisition if the situation is not handled
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carefully. Also sometimes when the integration plan is made, it is so rigorous that, it is
not possible to modify them to accommodate ground realities when the process starts.
Targets attitude and cultural differences
The cultural differences between the companies is said to be one of the main reasons for
resistance to integration, especially the management integration and communication
within the workforce which creates uncertainty. This is generally seen in cross border
merger and acquisition. Cultural differences reflect the way decisions are made between
the companies. The acquirers often take the communication process lightly and don’t
convey their plans and expectations and are not able to allay the anxieties of the target
personnel. Also the slack attitude and lacked self motivation of the target company’s
management plays an important role in the failure of the merger. Also the power
struggles can be noticed between the management of the two companies post-acquisition
if the situation is not handled carefully. Such a problem can be a constraint at the time of
increasing shareholder value.
Inexperience
Lack of knowledge and inexperience can lead to a poor pre-acquisition audit. Overpricing
can be a problem as sometimes the bidder pays an excess premium to the target
Inexperience as well leads to loss of valuable time and thus synergies are sometime lost.
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Over-optimism
Sometimes being overoptimistic and overconfident about the market conditions leads to
failure of the merger deals. Management always tries to present the greener side of the
deal in order to win the votes of the shareholders to accept an over price deal.
External environment
The external environment in the economy surrounding the deal is very complex and has
to be examined carefully before acquiring a company. Different countries have their own
rules under the sun and may be multifaceted. Sometimes the bidder forgets to examine
these factors and are nit prepared to handle the regulations that may be involved which
leads to a failure.
Lack of accountability
It has been seen that a number of people are ready to be involved and take credit for a
merger deal when it is announced, but if the result of the deal doesn’t turn out to be what
is expected the same personnel are not willing to take the responsibility for it. Also these
personnel have different incentives to close the deal and they often give priority to their
personal reward.
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3.3. THEORETICAL LITERATURE: CROSS-BORDER MERGERS
& ACQUSITIONS
There has been a substantial increase in the amount of funds flowing across nations in
search of funds flowing across nations in search of merging partners. Globalization has
prompted companies in the last few decades in cross-border M&A’s as privatization,
corporate restructuring and deregulation has been on the increase. In today’s world of cut
throat competition and survival, companies are always looking for a competitive edge has
followed their customers worldwide by way of cross-border M&A. This is the new
characteristic of modern business, which has affected all industries to one or another and
become a definitive business.
New strategies and tactical reasons prompt companies to go global, with the accelerated
motive of growth in order to have a greater market share and in order to achieve
maximum economy of scale with the access to cheap factors of production like raw
material, labour market, etc. It also provides financial protection to the company from the
market volatility, political and economical instability and changing business scenario.
CBA’s are complex is difficult due to differences in political and economic environment
, corporate environment , corporate organization, culture , tradition, tax rules, law and
accounting rules between the countries of the acquirer and the target company. Apart
from the company’s perspective, there are other economic forces which have promoted.
CBA’s such as the economic integration of the European Union by the single market.
Globalization of market, increase in competition, explosion of technology, availability of
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capital to finance acquisition and innovations in financial markets, etc. from the
company’s perspective, there are many reasons to go global like growth orientation and
to extend markets, access to cheaper inputs of production, to response to clients need and
the opportunities prevailing in the market.
But integrating a foreign acquisition is not an easy task but a complex one which presents
formidable problems. Since the acquired company manages its own staff and managers
who are not aware of the corporate governance structure of the acquirer, they need to be
reassured about the intentions of the acquirer. The interface between the two companies
must be handled with extra sensitivity. In carrying out the rationalization and the
redundancies, the local employment rules must be understood and complies with or the
acquirer may be bogged down in a bitter and prolonged confrontation.
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4. EMPIRICAL EVIDENCE: CONSEQUENCES OF
ENGAGING IN MERGER AND ACQUISITION
4.1. EVENT STUDY
An event study is an analysis of the reaction in the financial market, of whether there was
a statistically significant change to past occurrence of a given type of an event that is
hypothesized to affect public firm’s market value. Event study shows the change in return
to the shareholders in the period surrounding the announcement of a merger or an
acquisition. It is an empirical financial research and has been dominant in the field for
many decades now. ( MacKinlay, 1997)
The change in return or abnormal return is the shift in return expected; typically the
standard return is dictated by the Capital Asset Pricing Model (CAPM). Event study can
measure excess return to both shareholders of both acquiring and target firms. The first
event study is said to be done by Fama, Fisher, Jensen & Roll in 1969, who investigated
the stock splits to public listed companies.
Whether value is created or destroyed by a merger can be directly measured by event
study as it is a forward looking measure. It also has few backdrops as it requires many
assumptions about the stock market and event based study are prone to confounding
events, which could skew the returns for specific companies at specific events.(Bruner,
2002)
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But, most of the event based studies reveal that return to shareholders is mostly positive
post merger.
Evidence Using Event Studies
One of researches done in the recent past is by Andrade, Mitchell & Stafford in 2001. In
their paper ‘New evidence and perspective on mergers’, they try to estimate the reasons
for mergers and their long term effects. The reasons they advocated for mergers are
attempt to create synergies, to increase the market power and market share in order to
create monopoly and create market discipline by removing inefficient managers with
competent ones.
In their research, they use all the relevant data over a period of 25 years on M&A’s to
come to a conclusion. Measuring value creation or destruction post merger was central to
their research. The event window they used in their study was 3 days for a short period
and 20 days for a longer period, surrounding the announcement of the merger.
In their study they found that target firms shareholders benefit from a merger as there is
an increase in their abnormal return from 16% to 20% in longer window period. They
also found that there is an increase in the combined value of the firms of about 2% from
the initial value pre-merger. They also provide evidence that support that merger activity
strongly clusters by industry.
29
Loughran and Vijh (1997) examined 941 acquisitions between the periods of 1970-89, to
show the abnormal return to shareholders post acquisition. They differentiated their
sample on the basis of the mode of acquisition i.e. whether it was a merger, tender or
ambiguous and the method of payment i.e. whether it was done by cash, stock or both.
It was found that the mode of acquisition and method of payment, both were related to
the post-acquisition returns of acquirers stock. It was found that the return on acquirers
stock was less when payment was made through stocks and the mode was merger. While
the return were bigger when the payment for the acquisition was made through cash.
During the five year period following the acquisition, they found that firm that complete
cash tender offers earn positive returns of 61.7% whereas stock mergers earn negative
returns of -25.0%. They also found that the target firm’s shareholders don’t gain from all
types of acquisition.
Berkovitch and Narayanan (1993) conducted a research on the motives behind mergers
and if these motives had any positive gains on positive gains. Synergy, Agency and
Hubris have always been said to be the main reasons for takeovers but the existing
evidence then did not clearly distinguished the different motives. They used correlation
among target, acquirer and total gains to distinguish motives. Their sample consisted of
330 successful tender deals between periods of 1963 – 1988.
Based on the empirical evidence they concluded that total gains are mostly positive
indicating that synergy is the most of the time motive for a takeover. Some gains were
30
also found to be negative showing that agency and hubris also play a part in merger and
takeover.
Frank , Harris & Titman (1991) in their paper conducted a research to find the effect of
acquisitions on shareholder. They took a sample consisting 399 mergers in the United
States from 1975 – 1981.
They found that target firms shareholders gained from the announcement averaging 28%.
Acquirer’s shareholders don’t experience such gains but they don’t suffer any losses as
well. It was found that the target gained more in a cash deal as compared to a deal closed
with equity or mixture of securities. It was also seen that equity-bids show losses to the
bidder. They also show that the share price performance is sensitive to the benchmark
employed. Equally weighted benchmark showed negative post merger performance and
value weighted benchmark showed positive post merger performance, in their study.
4.2. ACCOUNTING STUDY
Accounting study is based on the reported financial results of the bidder’s pre and post
merger to check the change in financial performance. Financial ratios like return on
equity or assets, leverage, liquidity and earnings per share are some of the common tools
used in this study to find the change in financial performance. The study of the operating
performance provides an additional measure to check the result of the merger. The main
answer these studies provide is whether the merger resulted in giving an edge to the
acquirers over their competitors. (Bruner, 2002)
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“Accounting based studies use accounting-based measures (such as operating margins
and productivity-based measures)…to evaluate acquisition success”. (Kaplan, 2006)
For the purpose of this dissertation, I will also be conducting accounting based study
using ratios and financial statement as a tool to measure pre and post merger performance
of merged firms.
Empirical Evidence Using Accounting Based Study
Ghosh (2001) tried to show whether operating performance actually improve post
acquisition and whether the performance is of merging firm is related to the mode of
payment used.
To show the impact of merger on operating performance, he uses a sample of all the
mergers and acquisition from 1981 to 1995. Then he makes a comparison between pre
and post merger operating cash flow performance relative to the merged firms to
determine whether the operating performance had improves post acquisition.
In order to have a correct benchmark and remove bias in the regression analysis, he used
a research design that account for superior pre-acquisition performance and size and
firms were matched on this basis. And using this research design he found no evidence
that operating cash floe performance improves following acquisition against what was
concluded by Healy, Palepu & Ruback (1992) that cash flow performance improves post
acquisition.
32
He also came to a conclusion in his study that cash a mode of payment was a better
option in order to better utilise the assets of the combined firm and generate better wealth
gains for targets and bidders rather than equity as a mode of payment. Higher sales
rather than reduction in cost, was said to be the main reason for improved performance.
Dickerson, Gibson and Tsakalotos (1997) took a large sample of firms in the United
Kingdom of 2491 firms involved in mergers and acquisitions between 1948-1997, in
order to find whether there was a change in performance of the company following and
acquisition and what was the difference in return if a company opted for organic or
inorganic growth.
They found no evidence like Ghosh (2001) that acquisition did not resulted in an
improved performance in terms of profitability but on the contrary it had a negative
impact on profitability following the acquisition for few years. They also concluded that a
company’s performance was reported to be better if it opted for internal growth rather
than growth by merger and acquisition in terms of profitability.
Berger and Ofek (1995), in their paper tried to estimate the effect of diversification and to
find the potential sources of value gains or losses. They used segment level data to
estimate valuation effect of diversification.
Diversification as spoken earlier results in improved debt capacity, lower taxes, operating
efficiency and creates synergy. On the contrary their study showed these advantages
come from resources at the cost of better performing segments and these resources are
transferred to poor segments. Also diversification leads to a shift from the ultimate goal
33
and confusion. It may be said that diversification would lead to poor investments and
result in negative NPV.
They found an average loss in value from diversification of between 13%-15%. However
this is not the same if diversification takes place between related companies. Also the
diversification between unrelated lines of business showed the worst results. They also
concluded that diversifies firms had lower operating profitability than a related line of
business. They also found that tax shields were one of the major advantages of
diversifying due to increased debt. Contrary to the results of earlier researches done, they
concluded that diversification reduces value.
Ravenscraft and Scherer (1988) took a sample of 471 acquisitions from 1950 to 1977,
and employed the use of ratios such as operating income to assets cash flow. They also
concluded that there was no significant increase in profitability post merger. The
financial performance of the targets was said to decrease post merger, this was said to be
because of asset value write-ups of the target firm. Merger and acquisition in order to
diversify and purchase accounting were also reported to result in decrease in profitability.
He also concluded that the decline in performance was also based on how the accounting
rules were applied. For example pooling accounting showed better results post
acquisition as compared to purchase accounting.
34
Mueller (1980) in his paper collected a sample of many mergers and acquisition , in
United States and six European countries , to check the change in their performance and
change in profitability against three set benchmarks that were equity , assets and sales.
He found that the growth of acquirers is faster as compared to their competitors and their
targets acquirers are more leveraged than them. The main finding of his study showed
that the acquirers had less returns following acquisition compared to their competitors but
there wasn’t much of a difference. He concluded that mergers show little improvement in
performance and any gains from the merger tend to be small.
4.3. SURVEY OF EXECUTIVES
This study is done by simply asking the executives of the companies whether the
acquisition actually created value. Survey studies represent standardized questionnaires
for managers to evaluate the affect of a merger on the company. The answers of the
executives are then analyzed to come to a conclusion.
This approach has its advantages as it gives an insight into value creation that may not be
known in the market and the benefits from the intimate familiarity with the actual success
of the acquisition. Also it has some backdrop as the managers may or may not be
stockholders and their opinion may not be focused on economic value. Also to convince
the executives for participation is a task and typically surveys have a low rate of
participation. (Bruner, 2002)
35
According to Bruner (2002), ‘survey by practitioners is often casually reported, limiting
the ability to replicate the study and understand the methodological strengths and
weaknesses. For this reason, scholars tend to give practitioners surveys rather less
attention.’
Findings from Survey of Executives
Bruner (2002) conducted a survey by pooling 50 executives via the internet, to find the
affect of merger deals on their company and whether value was created or destroyed.
It was found after considering all the respondents that 37% of the deals created value for
the buyers. Also it was believed by them that only 21% of the deals achieve the buyer’s
strategic goals.
Then the survey focused on executives who were personally involved in a merger deal
and were asked to comment on it. The outcome was different. 58% of the respondents
said that their deal created value. 51% said that they achieved their strategic goal while
31% of the respondents didn’t agree with it. The remaining were not aware of the results
of their deals.
A survey conducted by Business week(1995) between a period of 1990-95 consisting a
sample of 248 acquirers purchasing a total of 1,045 targets, compared to 96 non-
acquiring firms , showed that 69% of non-acquirers produced returns superior to their
36
competitors. Also 58% of the acquirers produced superior returns to their competitors in
the respective industry. (Bruner, 2002)
A survey by KPMG International (1999) with a sample of 700 of the most expensive
merger deals between periods of 1996-1998 revealed that 17% of the deals increased
shareholder value while 53% reduced it. 30% broke-even. Interviews with 107 executives
showed that 82% of the respondents believed their deals were successful. (Bruner, 2002)
4.4. CLINICAL STUDY
Clinical studies concentrate on one event or small samples in great depth, usually through
field interviews with executives of the company and knowledgeable observers.
By going into the depth of the detail and actual motive of the deal, new results can be
found.
It is advantageous as it’s an inductive research and good for finding new patterns and
behaviors regarding a deal. It also has its weakness because of the small number of
observations; the researcher cannot do hypothesis testing. Also reports can be
idiosyncratic making it difficult for the decision maker to make larger decisions from a
single report. (Bruner, 2002)
37
Findings from Clinical study
Lys and Vincent (1995) researched on the acquisition of NCR Corporation by AT&T’s,
which resulted in decrease of the AT&T’s stockholders wealth by $3.9billion and
$6.5billion.
After their study they came to a conclusion that decrease in shareholders wealth
happened because maximizing shareholders wealth was not one of the objectives of the
executives and the managers were overconfident about the deal. They also concluded that
the decision to close the deal was taken despite of the knowledge of the consequences of
the deal.
A research was conducted by Kaplan, Mitchell & Wruck (1997) to show whether value is
created or destroyed following an acquisition. They studied two mergers, one was
Cooper industries acquisition of Cameron iron works and the other was Premark’s
acquisition of Florida tile and saw different share market reactions to their
announcement. One acquisition increased the share value and the second decreased it.
After various on field interviews with executives they concluded that both the
acquisitions didn’t create value. The causes for that was less knowledge about the target
firm and the imposition of inappropriate organizational designs on the target firm.
Ruback (1982) tried to find the affect of the takeover of Conoco by Dupont on
shareholder value. He examined the value creation to the shareholder of the buyer and the
target jointly. He found that Conoco’s shareholders received gains of $3.2billion and the
shareholders of Dupont suffered losses of $800 million.
38
He couldn’t find the reason for net gain of $2.4billion from the deal and was unable to
find a specific source. This study showed the possible difficulties that arise in a clinical
study.
39
5. RESEARCH METHODOLOGY
For the purpose of this dissertation, I would employ accounting study, in order to show
the change in financial performance of the company pre and post merger and acquisition,
using case study.
5.1. ACCOUNTING METHODOLOGY: THE BENCHMARK
APPROACH
Accounting methodology using the benchmark approach is one of the commonly and
frequently used accounting approaches to asses the performance of a company following
a merger or an acquisition. This approach compares the financial performance the
acquiring companies with either a non-acquiring companies in the same line of business
of a smaller size or with companies which have never engaged in a merger or acquisition
deal. (Bruner, 2002)
This approach has previously be employed by researchers such as Meeks(1977), Mueller
(1980), Dickerson, Gibson and Tsakalotos (1992), Ghosh(2001) and many more and have
already been spoken about in the empirical literature review.
Different ratios are employed to asses the financial performance of the company like
Return on Equity (ROE) and Return on Assets (ROA). Different values required can be
found in the balance sheet of the company. The income statement is also a major part of
40
financial statement of the company. The annual reports of the company can be found on
the internet or different published sources.
After conducting the ratio analysis, the next step is to compare the results with the values
of the benchmark company or companies, to compare the profitability. This benchmark is
usually one or more industry competitors in same line of business. If the value of the
ratios such as ROE and ROA is found to be less than that of the benchmark group, one
can conclude that the merger didn’t result in improved performance and didn’t create
value for the shareholders having a negative effect on profitability and vice-versa.
Strengths of accounting methodology
As cited by Bruner(2002) the strengths of this approach are :
Credibility-Statements are certified and accounts are certified.
Used by investors in judging corporate performance. An indirect measure of
economic value creation.
Weakness of accounting methodology
As cited by Bruner(2002) , The weakness of this approach are:
1) Possibly non-comparable data for different years. Companies may change their
reporting practices. Also reporting principles and regulations change over time.
2) Backward looking.
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3) Ignores value of intangible assets.
4) Sensitive to inflation and deflation because historic cost approach.
5) Possibly inadequate disclosure by companies. Great latitude in reporting financial
results.
6) Differences among companies in accounting policies adds noise.
7) Differences in accounting principles from one country to the next make cross-border
comparison difficult.
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6. CASE STUDY
6.1. AN OVERVIEW OF TATA TEA LIMITED
TATA Tea was set up in 1964 as a joint venture with a UK based James Finlay and
Company to develop value added tea. From a mere share of 3% in the mid 70's to become
India's second largest tea producer, Tata tea has come a long way. (www.tatatea.com)
The operations of Tata tea and its subsidiaries focus on branded product offerings in tea
but with a significant presence in plantation activity in India and Sri Lanka. The Tata tea
brand leads market share in terms of value and volume in India and has been accorded the
‘super brand' recognition in the country.
Tata tea also has 100% export oriented unit manufacturing instant tea in the state of
Kerela, which is the largest such facility outside the United States.
6.2. AN OVERVIEW OF TETLEY
In 1837, two brothers, Edwards and Joseph Tetley started to sell tea and became so
famous that they set up as tea merchants. In 1856, in partnership with Joseph Ackland,
they set up “Joseph Tetley and Co., wholesale tea dealers”.
Tea was rationed during World War II, it was not until 1953, just after rationing finished,
that Tetley launched the tea bag to the UK and it was an immediate success. The rest, as
43
they say, is history. The tea bag had captured the public’s imagination and desire for
convenience. Within 10 years it revolutionized how Britons drank their tea and the old
fashioned tea pot had given way to making tea in a cup using a tea bag.
1974 Tetley Tea Company was bought by J Lyons who merged it with the Lyons tea
business to form Lyons Tetley. 1978 Allied Breweries acquired J Lyons’ Businesses then
as Allied Domecq sold them in the 1990s. The Tetley Group was created in July 1995,
when a group of investors bought what was then the world-wide beverage business from
Allied Domecq. On 10th March 2000, The Tetley Group was sold to Tata Tea Limited,
one of the world’s largest integrated tea businesses. 1
6.3. THE HISTORY OF TATA TEA’S MERGER AND ACQUISITION
DEALS
Earlier, after a pitched battle among the MNC's in the domestic arena, not many Indian
tea manufacturing companies thought of going global. Devour competitors and destroy
competition - the mantra that the global conglomerates had been chanting so far, had not
gone well with the Indian counterparts.
But fortunately, that doesn’t remain the prerogative anymore. The war-averse domestic
companies are shedding their inhibitions. The roles, have undoubtly changed. And, after
fighting in out in the global commodities arena, it is time now for a global teacup.
1 See the following website for more information www.tatatea.com
44
Taking a plunge in the global tea war in the year 2000 was India’s corporate tea giant
Tata Tea. Though it was not an easy decision to make, that to when the competitor was
no less than a stature of Unilever, a global food and beverage behemoth, but the Tata Tea
had little choice - shape up or be swapped. It chose the former. And, what else could have
been a better vehicle than Tetley for Tata tea to take on the might of global tea giants like
Lever and Hillsdown2.
But that has not come to it easily. After a long drawn out battle first with Schroder
Ventures, followed by a bitter retreat in 1995, and then with Sara Lee, Tata tea finally
tasted victory on March 10, 2000 when it bought Tetley for a staggering INR2,135 crore
( 305 million sterling). Such a deal had never been heard or seen before in the Indian
Corporate world. What makes this deal special is the fact that it is the first ever LBO
(Leveraged Buy Out) by any Indian company. In fact, this also happened to be the largest
ever cross-border acquisition by an Indian company. 3
But more than the temptation was the urgency to perform, which caused a storm in Tata
Tea's cup. Glaring in the face were , and still are , the factors such as fall in exports to
Russia, growing competition in the domestic market, and above all the emergence of
competitors from Sri Lanka and Kenya, which the tea major could have afforded to
overlook at the cost of its own peril. Surely the deal could have not come at a better time
than this.
2 See the following website for more information: www.attimes.com 3 See the following website for more information: www.bbc.co.uk
45
The buy-out which Tata tea masterminded, would pitchfork it to a position where it can
rub shoulders with global behemoths like Unilever and Lawrie. The deal gives Tata Tea
an instant access to Tetley’s worldwide operations, including new territories and product
categories for both Tat Tea and Tetley.The combined turnover of Tata Tea was estimated
to be worth INR2800-2900 crore and would put it at the second position in the globl
arena.
6.4. BLENDING WITH PERFECTION
With a reserve of just over around INR400 crore in the year 1999-2000, it could not have
been possible for Tat Tea to go for such a gigantic acquisition on its own. Or, even
bringing such a colossal debt upon its own books could have meant putting enormous
pressure on the bottom line. So it went for Leveraged Buyout.
The deal was structured in such a way that although Tata tea retains full control over the
venture, the debt portion of the deal does not affect its balance sheet. The deal was tied
up through a leveraged buyout based on Tetley’s assets so that Tata Tea's gearing is not
impaired as a result of it.
Tata Tea created a Special Purpose Vehicle(SPV) - christened as Tata Tea(Great Britain)
- to acquire all the properties of Tetley. The idea of the SPV essentially was to ensure that
Tata Tea's balance sheet does not suffer additional funding costs, while at the same time,
allowing it to benefit from the acquisition of the international brand. The SPV had then
capitalized at 70 million pounds out of which Tata Tea had contributed 60 million
46
pounds, which included 45 million pounds raised through its GDR issue. The US
subsidiary of the company, Tata Tea Inc., had contributed the balance 10 million pounds.
The SPV had leveraged the 70mn pounds equity 3.36 times to raise a debt o 235mn
pounds to finance the deal.
The entire debt amount of 235 mn pounds comprised of 4 tranches whose tenor varied
from 7 to 9.5 years, with a coupon of around 11%, 424 basis points over the LIBOR. Of
that, the Netherland-based Rabobank had provided 215 mn pounds while venture capital
funds Mezzanine and Schroders each contributed 10mn pounds.
The debt was divided into four tranches, namely - A, B, C and D. While A, B, C were
senior term loans, tranch D was a revolving loan that takes the form of recurring
advances and letters of credit. Of the four tranches , the money from tranches A and B
was meant for funding the acquisition, while tranches C and D were meant for capital
expenditure and working capital requirements respectively.
Tranch A was a 110 million pounds loan scheduled to retire in 2007 this year through
semi-annual installments. Tranch B was a 25 mn pounds loan which is also maturing this
year in 2007 and would be paid back in two equal installments at the end of 7.5 years and
8 years respectively. Tranch C was a 10 million pound loan, maturing in 2008 and would
also be paid in two equal installments at the end of 7.5 and 8 years respectively. Tranch D
was a 20 million pound loan which was made available through advances, letters of
credit, overdrafts and is due to retire also this year.
47
The debt was raised against Tetley's brands and physical assets. The valuation of the deal
was done on the basis of future cash flows that the brand was expected to generate in the
foreign market as well as the synergy and benefits that Tata Tea was expected to receive.
Though the actual cost of the Tetley takeover comes through 271million pounds, Tata tea
spent 9 million pounds on legal, banking and advisory services and another 25 million
pounds for Tetley's working capital requirements and additional funding plans , thereby
swelling the total acquisition cost to 305 million pounds. Since entire securitization was
based on Tetley's operations, Tata Tea's exposure was limited to the equity component
only that was 70 million pounds only. 4
6.5. THE CHALLENGES
The challenges before the Indian tea companies were manifold in the last decade. And it
is not an exaggeration to say that their honeymoon with Russia was over then; the vigor
seemed to be out of the cup for most of them.
Rising competition from African nations such as Kenya and Malawi, where production of
tea is new and expanding, posed potential threats to tea exporters from India. Progressive
dismantling of quantitative restrictions had put the margins further under pressure.
Adding to the woes was the fact that the Indian tea exports to Russia had been
continuously declining. In fact the exports to Russia fell drastically over the last decade.
4 See the following website for more information: www.cmie.com
48
In 1999, the exports were around 87million Kg, which was almost half of 160 million Kg
exported in 1989. The overall export also fell substantially. During the last fiscal itself,
the exports saw much volatility. The total exports fell of tea fell from 27,839 ton recorded
in August 1999 to 9,766 ton in February 2000.
The litany of woes of the tea players also stems from the fact that the traditional user
markets like the UK and Ireland where Tea consumption, historically, had been very
high, however , actually has been showing a decline in the tea consumption. As per the
rough estimate, The UK and the Ireland accounted for one-third of the world’s tea
consumption in 1955. However their share in tea consumption currently is around 5%
only. Though , the popularity of tea has been growing rapidly in developing countries like
China, India , Pakistan and the Middle-Eastern countries, the worrying factor is that the
traditional savior of Indian Tea companies, Russia, is no more an assured market for it5.
The Tea consumption which grew rapidly in the erstwhile USSR in the eighties has
actually declined after its disintegration. In developed countries such as USA, Canada
and Japan also the consumption is quiet stagnant.
In recent years, the tea prices have falling worldwide because of an oversupply in
production. While world market prices in real terms have declined the cost of production,
on the other hand, has increased steadily thereby putting pressure on the producer’s
margins. Moreover, big buyers like Russia, Iran and Iraq have become inactive due to
5 See the following website for more information: www.teaauction.com.
49
political reasons. Above all, the fact that Sri Lanka is selling tea to Russia at far lower
prices than India, has also been causing major concerns6.
It has to be mentioned that tea prices show a great variation due to enormous diversity of
quality and unlike coffee, there is no single world market for tea, and prices are subject to
strong fluctuations. Though, given India's major share in the world tea production
(around 30% of world tea production in 1995), it might be expected that this would give
the country a key position in establishing tea prices, but this is not the case. And,
although the quality and quantity of the Indian tea crop has some effect on tea prices, the
impact is limited. The fact is that what is of far importance is the economic relationships
and the power of transitional companies.
And these apart, the premium that Indian tea commanded in the past has also been
gradually eroded through the quality of improved African teas. Which means, to ward of
the challenge from African countries like Kenya and Malawi, marketing campaigns have
to be built up quiet aggressively and that could be easier said than done. All these, no
doubt, have caused much storm in the teacup of domestic tea majors including biggies
like Tata Tea and HLL.
6.6. FLAVOUR OF SYNERGIES
In the backdrop of the difficult domestic scenario and dwindling exports to Russia is was
not difficult to conclude what prompted Tata Tea to go for an acquisition, that too at such 6 See the following website for more information: www.the-south-asian .com
50
a mammoth scale. As far as the scale of acquisition is concerned it could be said that
nothing less than this kind of acquisition could have been meaningful for the company.
That is because the domestic market comparatively growing at a better rate than the other
developed markets, 3% versus 1%, and rival HLL having benefits of access of access to
parent Unilever's latest technology in product innovation, development and packaging, it
could have been a difficult task for Tata Tea to go on its own to develop such
technologies and to face the competition. With the threats of imports from rival
companies looming large, its woes could have aggravated even further. 7
The major driving force behind Tata Tea- Tetley deal was the fact that Tetley fitted
perfectly into Tata Tea's globalization drive and could be a perfect launch vehicle to
achieve greater synergies in the global arena. This seems understandable because of the
three major factors:
• The acquisition brought with it a greater market penetration.
• This helped Tata Tea's operating efficiency, as Tetley's operating margins were
superior in comparison to Tata Tea, 20% vs 14% in 1999-2000.
• The acquisition would have resulted in instant expansion of product lines of Tata
Tea- Tetley combine.
The synergies that would have accrued to the combine entity as a result of the deal were
supposed to be quiet significant. On the one hand, while Tata Tea was supposed to get
access to Tetley's strong brands and its worldwide distribution network and about
7 See the following website for more information: www.Ft.com
51
INR1900 crore of sales, on the other hand, Tetley was supposed to benefit from Tata
Tea's competencies in managing plantations and processing units. Tata Tea though didn’t
have expertise in blending and branding. It was here that the acquisition was coming
handy to Tata Tea, as Tetley had proven expertise in the area of product innovation and
in sourcing tea from auction houses and which also was a major blending and packaging
company and owns a host of well-known international brands which the latter can
leverage8.
Tea is usually exported at a relatively early stage in the production chain and blending
and packing, the most lucrative part of the tea trade, is mostly done by the tea companies
in the buyer country. The large profits therefore don’t accrue to the tea producing
countries. The big money is made abroad. In Europe, 30% to 50% of the consumer price
of tea goes to blending, packaging, materials and promotion.
It was there that the acquisition would help Tata Tea to take advantage of the existing
scenario by virtue of Tetley’s proven skills an blending and branding, not to mention
exotic packaging, which too fetches higher premiums. Also, many producers try to sell
processed tea bags or repacked consumer units, but the export of ready-for-use tea is
often hampered by poor market information and the absence of funds for expensive
marketing strategies.
It could be rightly said then that the deal was supposed to bring together the two
companies, one of which was the largest integrated tea company (Tata Tea) in the world,
while the other world's largest brand (Tetley). Together they make a world-class
8 See the following website for more information: www.hoovers.com
52
integrated outfit. But the rival Unilever was not far behind either. In fact, it became even
more aggressive after the Tata Tea- Tetley deal came through. The Unilever through its
Indian outfit HLL acquired Rossell Industry's tea gardens, and stepped up efforts to
vertically integrate its operation by acquiring some more tea garden in India and African
nations like Kenya, Uganda and Mozambique.
The deal was supposed to facilitate downstream segment also. Tata Tea has over 60 tea
gardens in India and Sri Lanka, besides its own blending and packaging units. Tetley on
the other hand, buys tea from the major auction markets of the world and processes them
to be sold under its own brands like Earl Grey , English Breakfast and Traditional
Afternoon - in the US, Canada UK and Australia. Both the companies were supposed to
streamline their downstream operations quite efficiently thereby cutting the costs. Tetley
plans to give special thrust to the US market, which has been fast emerging as a growing
tea market, with consumers shifting from coffee to tea due to health reasons. This is turn
was thought to help Tata Tea to push greater volumes in the instant tea segment, where it
had so far struggled to get a strong foothold.
In the domestic market, on the branding and packaging front, there has been a major
strategic shift towards brand consolidation. In fact, with increase in the value added
segments over the years, the share of this segment has risen quite significantly. The value
additions, through changes in the product forms, branding, consumer awareness and
delivery systems, which has been part of the winning tool in the international markets
was bound to be replicated in the Indian markets too. And it was there that the Tata Tea -
Tetley combine's wider product portfolio downstream would compliment the upstream
53
synergies. As while, Tata Tea catered primarily to the lower end of the market segment,
Tetley had presence in the premium segment. Apart from that, adding to Tata Tea's brand
strengths in developing packaged tea was Tetley's well-entrenched presence across a
wider range of categories such as decaffeinated, herbal, lemon tea, and tea bags, etc.
As far as other major benefits from the deal were concerned, the domestic company can
benefit from the standardized management practices including quality performance
norms and consumer focus of Tetley, the world leader in tea bags. This was supposed to
be more so when new products are envisaged for the Indian markets. On the other hand,
Tata Tea's strong R&D base and expertise in tea cultivation and manufacturing was
immensely helpful to Tetley.
Post-acquisition, the decision was that the two organizations work under a unified global
strategy. The combine strengths were thought to be helpful to create opportunities to
expand sales in both the existing and new markets and realize synergies. Apart from that,
the two companies’ breadth of experience and vertical integration was equipping them to
compete anywhere in the world and that assumed importance in the context of WTO,
which would terminate tea import curbs under its predetermined timeframe9.
The joint buying power and commercially relevant use of tea produced by Tata Tea was
also supposed to facilitate cost control. Also among the other immediate priorities was
the strategy to increase tea bag sales in East Europe and to improve upon the currently
token presence of Tetley in the packet tea segment. On the product size, Tetley proposed
to promote the draw size string bags in a bigger way, because of the higher margins and
9 See the following website for more information: www.envestindia.com
54
planned to replace all the round tea bags cartons with an innovative soft-pack format
then.
Another area that Tata Tea was eyeing was the private label tea business in the UK.
Tetley which holds sway over the market, with 6 out of every 10 retailers sourcing tea
from it to sell under their own brand names, was a perfect launch vehicle to push greater
volumes into that highly lucrative segment, more so when its exports to the Russian
markets had been had been on a continuous decline. The key reason why the private label
was lucrative was that there were no marketing costs attached to it. That meant, by
sourcing tea directly from its 26,000, hectares of gardens, or from the auction markets,
Tata Tea would be able to boost its margins. Surely the deal could not have come at a
more opportune time than that one for Tata Tea.
The acquisition impact on Tata Tea's presence in the global tea trade aside, Tata-Tetley
ltd., the already existing joint venture between the two companies, was seen aligned with
the group’s international operations. Equally significant was the domestic company's plan
to open an instant tea factory in South India, which was improved for the instant tea
shipments to the US, where Tetley had a major presence. Tata tea hoped to garner greater
market share and stave off the competition, riding on Tetley's strength.10
Acting swiftly, Tata Tea initiated a comprehensive operation restructuring of the world's
second-largest tea company, in a bid to move a step closer to unseating Unilever Plc. The
restructuring took forms of the broader plan to venture out into new market in East
Europe, Russia, the CIS and West Asia through both the joint venture and franchise
10 See the following website for more information: www.cmie.com
55
route. The move was critical to increasing the UK based transitional earnings potential as
Tata Tea had leveraged the company’s future cash flows to fund the 271 million pound
acquisition.
As part of the recast plan, Tetley, which had the world’s single largest tea brand, was
shifting its focus from black tea to higher value added products like green tea, flavored
tea and herbal tea.
6.7. GLOBAL SCENARIO
The tea industry worldwide in the last decade was going through a phase of transition.
And, over the past few years many new development have taken place. The spate of
mergers and acquisitions, in the tea industry, had touched the Indian shore in a big way.
And it was the awakening call that got a prompt response and witnessed the coming of
the world's two tea giants, Tata Tea and Tetley, together. Surely, there was a flavor of
uneasiness in everyone's cup of tea. The following factors could throw a light on some of
the reasons for this uneasiness and that concerned one and all in the tea industry
worldwide11.
11 See the following website for more information: www.aes.co.uk
56
1) Growing Disparities
Developing countries in South Asia and East Africa account for 85% of the world tea
production and exports. India and Sri Lanka are dominant in both. Developed countries
account for about 62% of the world tea imports. The larger tea imports include the UK,
The US, the Netherlands, Australia, Canada, Japan, South Africa, Ireland and Russia.
India and China rank as the largest and second largest in tea production as well as
consumption. They export about a quarter of their production and have about 30% of
share in global trade. Kenya Indonesia and Sri Lanka produce 25% of the world tea but
control 50% of the global trade. They export around 85% of their production.
During the last four decades Kenya has increased tea production by tea production by 25
times. China tea production has witnessed a CAGR of 4.6%. On the other hand, the
production growth has been relatively much slower in India and Sri Lanka at 2.3% p.a.
and 0.9$ p.a. respectively during the same period. The area under cultivation, during the
last four decades has gone up by 33% in India whereas in Kenya, it got multiplies the
times during the same period.
Tea production is concentrated in a few countries due to suitable climate, soil and
availability of cheap labor. India is placed poorly as far as labor cost and crop-
productivity is concerned. The stringent labor laws have also caused much hardship to the
domestic companies. Whereas countries like Sri Lanka and Kenya are not only having
57
not-so-stringent labor laws, but also enjoy superior crop-yield and cheaper labor12. The
UK is the second largest importer of tea after the Russian federation. In 1995, the UK
imported around 1.36 lakh tons of tea, around 135 of total tea imports. This is more than
that imported by the rest of Europe. Which means that any changes in the UK market
would, therefore, have a direct impact on producers? But this traditionally staid market is
currently undergoing considerable change. The demand of tea has been slowly bur
steadily been falling as customers have been switching to coffee and especially to soft
drinks. Nevertheless, tea is still the most preferred and number one drink there and thw
world tea major's have been fighting hard to maintain market share and stimulate the
demand. Total demand for tea was estimated at 2.7 bn kg in 1998, which is growing at
about 2% p.a.
2) Competing For The Global Tea Cup
The world over, there has been a discernible trend towards consolidation of the existing
tea plantation in the hands of a few large corporates, stemming from the compulsions of
production and economies of scale This had been in the form of estates and companies
being bought over by larger estates to have a larger corpus of tea. Most tea companies
had been sharply redefining their scales of production costs and are being looked at more
closely. And this trend is expected to continue in future too, in the wake of increased
competitiveness which would compel companies to go for a complete reorganization of
12 See the following website for more information: www.tbi.com
58
production parameters be its machinery, leaf handling, plucking standards, and
configuration in drying technology, etc.
Even today, the tea industry worldwide is highly concentrated in the hands of a very few
firms like Unilver, Hillsdown Holdings, Lawrie Group, James Finlay, The Cooperative
Wholesale Society , Tata Tea, etc. And above all, the concentration of the industry is
such that the top three firms have a 60% share of the market of the UK, 9% in France,
67% in Germany and 66% in Italy.
These companies enjoy tremendous bargaining power over the others in terms of pricing.
This could be gauged from the fact that though the prices of tea is largely determined by
supply and demand , large tea companies such as Unilever and Tetley have tremendous
influence on supply and demand and thus on the price fixing process
As far as market concentration is concerned, this too is extremely high and around 90%
of the western trade is in the hands of seven transnational’s and almost 70% of the world
tea production is sold by transnational’s. The market power is a major determinant at tea
auctions. With their buying policy, these companies strongly influence both price
movement and the demand for certain qualities of tea. While on one hand, their
ownership of both plantations and processing factories give them the advantage of
horizontal integration, on the other hand, they also have the vertical integration as they
control transportation companies, shipping agencies and so on. This concentration of
59
power, with companies sometimes controlling the entire production process from tea
shrub to tea bag, offers ample scope for manipulation13.
Transnational giants can afford such auctions thanks to their high degree of flexibility,
their buffer stocks and their speculative auctions.
3) Demand Pattern
Shifts in the consumption of demand for tea in the developed importing countries have
had unfavorable effects on aggregate export earnings from tea. The increasing use of tea
bags and soluble instant tea effectively reduces the quantity of tea needed per cup and
also raises the demand for plain cheaper tea at the expense of that of high quality. Tea
bags, alone, account for about 10% of the volume of world production. Factors that seem
to have stimulated consumption of instant tea include its ease of use as a cold drink and
growing prevalence of vending machines. It is these changes in the consumption patterns
of tea that contribute to the decline in tea prices.
4) Changing Faces Of Tea
Tea has undergone a shift in its image in many markets. There has been a shift in the
production form from hot to cold, from the conservative to the flavored, from sheer cup
page to convenience. And, it is the transnational tea companies that have cashed in on
this trend.
13 See the following website for more information: www.marketradefair.com
60
Tea bags, the most common form of value-addition, dominate the world market. Almost
75% of the UK tea drinking population prefers tea bags, tagged, round and pyramid
shaped bags for a convenient brew. Tetley remains the market leader in tea bags right
from its inception way back in the 40's. 14
Significant innovations have been introduced in the instant tea segment also. It has been
most preferred form tea drink in the US, so far. Recently, the European markets have also
evinced interest in instant tea.
Product innovations have continued with introduction of iced tea, specialty tea, and
gourmet tea in the ready-to-drink market. In the US, this category has grown by leaps and
bounds. Flavored tea is also fast catching up the fancy of both tea drinkers and makers as
well, in the western markets.
5) Gatt (WTO) Impact on World Tea Economy
In the last decade there has been a lot of hue and cry over the WTO impact, especially in
the domestic market. But the domestic industry's fear about one of the major implications
of GATT Treaty (which was in the form of reduction in import tariffs) does not seem to
have much substance. It was to be mentioned there that WTO required member nations to
reduce import duty by 24% from the existing rates, by 2005. Among the importing
nations, Pakistan and Egypt have high import duty of 45%. The developed nations (UK,
USA) already have nil duty and therefore, require a special license. The impact on Indian
domestic industry would have been negligible. Tariff reduction was likely to cause higher
14 See the following website for more information: www.teagenius.com
61
imports by Pakistan, Iran, Iraq and Egypt. India and other exporting countries were
supposed to benefit from free trade and lower trade barriers. According to a rough
estimate done in 1999, the consumption was supposed to grow at 3.3 % p.a. in the
developing nations and at 1% p.a. in the developed nations, till the year 2005. Developing
countries share in the world consumption was estimated to rise from 63% to 72%15.
6.8. FINANCIAL ANALYSIS OF TATA-TEA PRE-ACQUISITION
An analysis of Tata Tea's financials for the last five years ending March 31, 1999
suggests that there had been a significant improvement in the pre-tax income from
operation. It increased from INR1180.60 million in FY ' 98 to INR1578.10 mn in FY' 99.
The pre-tax income in 1998 itself grew tremendously by 74% over previous years figure's
of INR.4854 crores . Though other income has been showing a decline over the last four
years, it increased marginally in 1998-99
Net sales and net profit registered at CAGR of 20.8 % and 21.4% over the last five year
period ending March 31, 1999. On a y-to-y basis, net sales declined 2.5% in the FY'99,
due to discontinuation of company's international coffee trading business. The continuing
business recorded 22% y-o-y growth in sales in FY'99.
Return on net worth (RONW) had been showing a healthy improvement on y-o-y basis. It
grew to 30.82% in 1999, as against 28.53% recorded in 1998. It showed a huge jump in 15 See the following website for information: www.indiainfoline.com
62
1998 as against 18.55% registered in 1997. Return on capital employed (ROCE) too has
improved gradually over the period, indicating efficient utilization of funds and improved
productivity. It grew to 37.60% in1999 from 35.07% registered in 1998.
Both Operating Profit Margin (OPM) and Net Profit Margin (NPM) rose significantly to
26.71% and 14.55% in 1999 from 22.05% and 11.62% respectively in 1998. PBDIT
margin excluding other income jumped from 18.9% in FY'98 to 23.8% in FY'99, despite
rise in packing, advertising as well as employee cost, mainly on account of lower raw
material, cultivation and manufacturing costs.
Although Cash Flow, as a percent of gross sales, declined substantially to 18.86 % in
1999 from 25.07% in 1998, it clearly showed considerable improvement over a low of
6.47% recorded in 1997.
Value sales of tea, both loose as well as poly packs, registered a growth of 23% on y-o-y
basis, whereas volume declined by 2.4% on y-o-y basis, indicating higher realizations.
Both the gross profit margins and the net profit margins have risen significantly over the
years. The gross profit margin grew to 26% in 1999 from 23% in 1998. The net profit
margin, at the same time, rose to 13.6% from 11.6%, during the said period.
The tax outgo has been showing a continuous increase during the last few years. And, in
fact, recorded almost 100% jump in 1997-98 when it rose to INR.420mn as against INR.
240mn in 1996-97. In 1998-99, the total tax outgo was to the tune of INR 560mn. The
cash profit recorded similar growth between FY'96 and FY'99. It grew to INR.14, 643mn
in 1998-99 from INR. 558.2mn in 1995-96.
63
The inventories recorded a significant jump in 1999 to INR.487.2mn from INR.205.3mn
in 1996. Sundry debtors have shown a declining trend in the year 1998-99. It fell to INR
11.8mn in 1999 from INR 356.9mn in 1998. Sundry creditors too have shown a similar
trend during the period. the decrease in sundry creditors was to the tune of INR 256.7mn
as against INR 92.7mn in 1998.
Fixed asset increased to the tune of INR 503.6mn in 1999 compared to an increase of
INR 432.9mn in 1998. Investments were to the tune of INR 532.8mn in 1999. Loan and
advances declined to the tune of INR 380.8mn in 1999.
Raw material cost fell to INR 232.18 crore in 1999 from INR 286.96 crore in 1998 on
account of lower purchase of finished goods. It declined quite substantially to INR 35.40
crore in 1999 as against INR 131.93 crore in 1998.
Gross working capital cycle increased from 176 days in 1998b to 185 days in 1999.
However, net working capital cycle fell to 126 days in 1999, as against 132 days in 1998,
as a result of rise in creditors' days, which grew to 59 days in 1999 from 44 days in 1998:
reflecting company's ability to avail credits for a good number of days from its creditors.
Also, fall in debtors days to 35 in 1999 to 43 in 1998 meant efficient management of
receivables. as a result of rise in creditors' days, net working capital requirements fell to
INR 197.50 crore in 1999 as compared to INR 227.82 crore in 1998.
Short-term liquidity got affected, although marginally, as cash-to-current liability ratio
fell slightly to 0.26 in 1999 from 0.28 in 1998. Quick ratio similarly showed a marginal
64
decline to 0.51 in 1999 from 0.53 in 1998. Current ratio fell to 1.53 in 1999 from 1.72 in
1998.
The excise duties saw a steep rise to INR32.96 crore in 1999 from INR6.72 crore in
1998. The sales and advertising costs too rose significantly to INR102.16 crore in 1999
from INR70.58 crore in 1998. Of this, advertising expenses, alone, increased sharply
from 5.1% of net sales in FY'98 to 8.7% of net sales in FY’99. The distribution cost on
the other hand actually declined, albeit marginally, to INR17.10 crore in 1999 from
INR17.71 crore in the previous year.
Interest cost declined by 24% on the y-o-y basis in FY’99, with the prepayment of the
part of the foreign currency loan from ICICI bank and repayments of NCDs. This was
result of the company's short-term debt portfolio. Keeping in view of the remaining
tenure of this loan and the depreciation in the value of rupee vis-à-vis US dollar, the
restructuring of the loans could work out to be effective. As a consequence of decline in
debt position, interest coverage ratio rose to 7.13 in 1999 from 5.60 in 1998, indicating
improved debt-servicing ability.
Though, the debt-to-equity ratio declined from 0.8 in 1998 to 0.5 in 1999, as a result of
prepayment of FOREX loan from ICICI, with the issuance of 75.98 lakh Global
Depository Receipts (GDRs) to part finance the acquisition of Tetley, it would rise, albeit
marginally. Depreciation has increased over the years with the company incurring capital
expenditure on modernization of its facilities and acquisition of plantations. In 1999 itself
the depreciation rose to INR17.67 crore to INR14.66 crore in 1998.
65
The company distributed dividends to the tune of INR53.49 crore in 1999, up from
INR49.11 crore distributed in 1998. Cash profits were to the tune of INR146.43 crore in
1999 as against INR116.83 crore in 1998. Total reserve and surplus at the end of the
financial year 1999 was a comfortable 399 crore. The effective tax rate has been around
32-33% in the year 1998 and 1999.
(Data source: annual reports of Tata-tea from the financial year 1995-96 to financial year
1999-2000).
6.9. LEVERAGED BUY-OUT
An LBO is defined as the acquisition, financed largely by borrowing, of all the stocks, or
assets, of the hitherto public company by a small group of investors. In an LBO, debt
financing typically represents 50% or more of the purchase price. The debt is secured by
the assets of the acquired firm and is usually amortized over a period of less than ten
years. As funds are generated by operations or from the sales of the assets of the acquired
firm the debt to be paid off is scheduled. The sale of the assets occurs when the investor
group is motivated to take control in part because of what it considers unwise or ill-fitting
acquisitions by the firms in the past.
There may be limited equity participation on the part of outside investors such as pension
funds and insurance companies often with the provision that the equity interest would be
repurchased after pre-determined period to provide a specified yield.
66
Following completion of the buy-out, the company is usually run as a privately held
corporation rather than a public corporation, at least for some years, after which resale of
firm at a profit is anticipated.
LBO is implemented for the following:
To generate additional cash flow from interest tax shields.
Reduce capital expenditures.
Sale of assets.
Studies have shown that high leveraged, concentrated equity ownership by managers and
monitoring by the LBO sponsor firm creates an organization form whose incentive
structure leads to value maximization.
In particular, increasing the proportion of equity owned by mangers can provide
increased incentives for managers to create shareholder wealth. In addition, substantial
debt service obligations can force managers to use particular care in seeking investment
opportunities.
Finally, non-management insiders typically own a significant proportion if outstanding
equity and exercise considerable control over managers through the board of directors.
Thus they enhance monitoring within the organizations. Other studies have documented
an improvement in the operating performance as the change in the organizational
incentives16.
16 See the following website for more information: www.moneyterms.co.uk
67
7. CONSEQUENCES OF TATA TEA’S ACQUISITIONS OF
TETLEY
7.1. NET SALES REVENUE
The net sales revenue had been gradually increasing from 1998 to 2007. The changes are
reflected in the graph 1 (a)
68
From the above chart one can clearly observe the significant increase in the sales, which
had grown gradually from INR 68772.00 millions in the financial year 1997-98 to INR.
105447.00 million in the financial year 2006-07.
Hence one can conclude that the acquisition activity contributed an increase in sales
volume.
Net Sales ( INR in Lakhs)
0
20000
40000
60000
80000
100000
120000
1998 1999 2000 2001 2002 2003 2004 2005 2006
YEAR
NET
SA
LES
Net Sales ( INR in Lakhs)
69
7.2. POST-MERGER FINANCIAL PERFORMANCE
In order to evaluate the consequences of the M&A activity, I compared the financial
performance of Tata Tea Ltd., with the performance of its competitor Hindustan Lever
Ltd., a subsidiary of Unilever.
Hindustan Lever Ltd.(HLL) is one of the largest producer of tea and two major brands
Lipton and Brooke Bond. HLL has also been involved in M&A activities over the last
decade. Hence HLL constituted the benchmark company. By comparing the financial
performance of HLL and Tata Tea Ltd., I tested the following hypothesis:
Hypothesis
M&A activity have a negative impact on Tata Tea’s profitability that is ROA and ROE
of the company are negative and lower than that of competitors.
Table 1(a) and Table 2(a) below show the net sales, EBIT, ROA, net income (loss) and
ROE of Tata Tea and Hindustan Lever Ltd. for the periods between 2001 and 2007. The
companie’s annual report, were found on their websites.
Table 1(a): Profitability of Tata Tea Ltd. over the periods of 2001 to 2007
YEAR Net Sales
(INR millions)
Net Income
(INR millions)
Total
Assets
(INR millions)
ROA*
% per year
Total
Equity
(INR millions)
ROE**
% per year
70
2001 67441 89116 146923 60 89698 99
2002 71232 81606 15230 53 96799 84
2003 74103 80648 154024 52 97863 82
2004 77002 83845 142017 59 97524 85
2005 88632 95024 152908 62 104897 90
2006 96820 104017 169743 61 116126 89
2007 105447 114611 270461 42 156555 73
Av. 82954 92695 169768 55 108485 86
*ROA is calculated as net income/total assets
**ROE is calculated as net income/total shareholder’s equity.
(Data Source: Tata Tea Annual Reports, 2001- 2007)
Table 2(a): Profitability of Hindustan Lever Ltd. over the periods of 2001 to 2007
YEAR Net Sales
(INR millions)
Net Income
(INR millions)
Total
Assets
(INR millions)
ROA*
% per year
Total
Equity
(INR millions)
ROE**
% per year
2001 67441 14188 39563 35 304369 4
2002 71232 17358 40423 43 365887 4
2003 74103 24359 34198 71 209270 11
2004 77002 22483 36157 62 213872 10
71
2005 88632 23870 42118 56 209270 11
2006 96820 24240 40300 60 230562 10
2007 105447 22050 48553 45 272348 8
Av. 82954 21221 40187 48 257940 8
*ROA is calculated as net income/total assets
**ROE is calculated as net income/total shareholder’s equity.
(Data Source: Tata Tea’s Annual Reports, 2001- 2007)
Testing Hypothesis: The period of 2001-2007
Consider the period of Tata Tea’s dynamic investment strategy:
From table 1(a), one could observe that although Tata Tea’s net sales had been increasing
from 2001 to 2007, the measures of financial performance indicate stagnant financial
status of the company. The ROA and ROE of the company has moved insignificantly to
show the benefits of Tetley’s acquisition. The average ROA and ROE during the period
of 2001-2007 are 55% and 86% respectively.
This implies that the company though has been making profits on total assets and
shareholder’s equity possessed, but at a slow rate.
At the same time HLL had an average ROA and ROE equal to 48% and 8% respectively.
The company’s performance is similar to that of Tata Tea. HLL has also been showing
72
increased profits at a slow rate and it has also been involved in various merger and
acquisition over the last decade.
Hence one can conclude that the acquisition activity by Tata Tea had a positive impact on
its profitability and contributed to shareholder’s value during the period of 2001 to 2007.
Hence the Hypothesis is rejected.
73
8. CONCLUSION
The purpose of this dissertation was to examine M&A activity in the tea industry and
analyze the effectiveness of this strategy as a prime instrument of company’s competitive
strategy. In order to answer the research question, an analysis of main trends of tea
industry development with the focus on M&A activity through the example of the recent
acquisition of Tetley Limited by Tata Tea Limited was undertaken.
Mergers and Acquisitions are the most important components of modern corporate
finance. The growing tendency of capital concentration and company’s preference for
external expansion, rather than internal way of development, determines the significance
of mergers and acquisitions within the bounds strategic planning of company’s
development.
The increasing number of M&A activity all around the world became possible because of
increasing convergence of underlying knowledge-based assets due to worldwide
competition and globalization, which gave an opportunity for companies to expand their
M&A activity not only domestically, but also on international arena through cross-border
cooperative activity. The M&A activity have a continuous nature and worldwide process
of capital concentration is far from completion.
I would like to summarize the findings my research in the following points:
74
First of all, I discovered that Tata Tea Ltd. had a major acquisition deal of Tetley in the
year 1999-2000. Also at the same time, Tata Tea’s competitors Hindustan Lever Ltd.
were also involved in a series of M&A activities.
Secondly, I found that both the companies engaged in M&A activities because they
wanted to increase their market shares and increase profitability. When Tata Tea acquired
Tetley, it was concerned with strengthening its position and to diversify geographically
through a dynamic merger activity.
Thirdly, I uncovered that the consequences of the merger activity. Tata Tea Ltd. steadily
increased its market share and had significant variations in the market share over the last
few years. The overall affect of the acquisition on market share ranged from neutral to
positive. Nevertheless Tata Tea boosted sales revenue and shareholders value.
The financial performance of Tata Tea improved though at a slow rate and both ROA and
ROE had been positive so far.
M&A’s waves are sweeping across the tea industry worldwide. Surely, the decision to
acquire Tetley could be termed as prudent and at the right moment for Tata Tea. More so,
when rival Lever is hell-bent to take vigor out of other’s cups of tea.
About the Tetley’s acquisition, it could be said that given the intensity of competition and
fast changing business environment in the tea segment, the world over, it, undoubtedly, is
75
a strategic fit for Tata Tea in the driving seat in world’s two largest market’s, the UK and
US, but should also make it inroads in other lucrative markets like Middle East and the
rest of Europe.
76
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