mf0011 slides unit 02

MF 0011 –Mergers & Acquisitions

Unit 2 – Strategic Evaluation of M & A Opportunities

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Program : MBA

Semester : III

Subject Code : MF 0011

Subject Name : Mergers and Acquisitions

Unit Number : 2

Unit Title : Strategic Evaluation of M & A Opportunities

Lecture Number :

Lecture Title : Strategic Evaluation of M & A Opportunities



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Objectives:

After studying this unit, you should be able to:

• Analyse the facets of strategy in a typical merger or acquisition

• Define selection criteria for identifying acquisitions

• Explain the process of fixing price for acquisitions

• Describe feasibility analysis for cash and stock transactions

• Explain fair value: Institutional criteria

• Discuss acquisition of sick companies

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Strategic Evaluation of M & A Opportunities



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• Introduction

• Approaches for Selection Criteria

• Fixing Price for Acquisition

• Determination of Exchange Ratio

• Feasibility Analysis: Cash Acquisitions

• Feasibility Analysis: Acquisition for Stock

• Fair Value: Institutional Criterion

• Acquisition of Sick Companies: Historical Case

• Summary

• Glossary

• Check Your Learning

• Answers

• Case Study

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Lecture Outline



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An acquisition is a major event for any corporate entity and requires considerable strategic inputs.

Some points to remember here are:

• It is important to know what makes a merger a strategically sound decision.

• The growth-by-acquisition strategy enthralled many investors and companies during the bull market.

• A well-timed and disciplined deals done might at times help companies to build dominant positions in their respective industries. On the flip side some mergers do not produce any significant benefit to the stockholder and might have to be revoked.

• There is no must-win formula for ensuring success of a merger, it is worth recounting the strategic aspects to be looked into in a decision to acquire a business.

Introduction



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Introduction (Cont.)

The sequence of competent management is:

Goal Setting Strategy Structure

• Without strategic goal-setting and activity planning, the business model is unlikely to succeed.

• Therefore it is necessary to explore the strategic goals and action plans associated with M & A activity.



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Approaches for Selection Criteria

Purpose of valuation is to locate possibilities of takeover:

• Identification of target companies for takeover

• Fixing exchange ratio in case the target company is finally selected for acquisition

Approach to Selection Criteria

Present Value Analysis

Capital Assets Pricing



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• The present value analysis is mostly similar to valuation on the basis of steady-state earnings and/or dividends for listed companies.

• The earnings or the target firm are projected and discounted at the acquirer’s cost of capital to obtain a theoretical market price of the shares of the target company.

• This is then compared with the actual market price to determine the net present value of investment in the target company.

Present Value Analysis

Click here to solve a problem on Theoretical Price

Approaches for Selection Criteria (Cont.)



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• This approach provides a superior theoretical framework as it also factors the risk.

• The basic logic behind the model is that if expected rate of return, considering the risk element, exceeds the required rate of return, the target company is a good buy.

Capital Assets Pricing

The required rate of return is calculated by solving the following equation:

E(Rj) = Rf + [E(Rm) – Rf] (Bj)

Click here to solve a problem on Rate of Return

Approaches for Selection Criteria (Cont.)



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Fixing Price for Acquisition

Factors the price fixed for acquisition depends upon:

The keenness of the target company in getting sold

The extent to which acquirer is willing to go for the acquisition and

the willingness of shareholders of the buying company

Factors determining the strengths of two companies in mergers or acquisitions:

Bargaining power Liquidity Strategic Assets Management Capabilities

Tax loss carryovers Production costs Investment values



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Market price of Shares

•If both are listed companies, the stock exchange prices of the shares of both the companies should be considered before commencement of negotiations or announcement of the takeover bid.

Dividend Payout Ratio

•Dividend paid by both companies in the immediate past is important as the shareholders want continuity of dividend income. If the target company’s DPR is lower than the acquirer’s, then its shareholders may opt for share exchange for the growth company by sacrificing the current dividend income for prospects of future growth in income and capital appreciation.

Price Earnings Ratio

•PERs of both companies as well as the future growth rate of combined company would be important factors.

Debt Equity Ratio •Company with low gearing offers positive factor to investors for security and stability rather than growth potential with a geared company having capacity to expand equity base.

Net Assets Value (NAV)

•NAV of the two companies should be compared. If the NAV is low, the company has the threat of being pushed into liquidation.

Determination of Exchange Ratio

Factors determining the share exchange ratio in a share exchange merger

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Feasibility Analysis: Cash Acquisitions

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Considerations for feasibility assessment for cash payments in takeovers and mergers

Quantum of cash required

Liquidity of the acquiring

company

Debt equity ratio of the target

company

Post-merger debt capacity is assessed by multiplying acquirer's equity by targeted debt equity ratio.

In cash transactions, the acquirer company's shareholders equity remains unchanged.

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Feasibility Analysis: Cash Acquisitions (Cont.)

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Click here to a solve a problem on Acquisition

for Cash

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Quantum of cash for acquiring the target company is assessed keeping in view the liquidity of the combined company (post acquisition) as under:

Debt capacity post-merger

Less: Total debts of the two companies (pre-merger)

Plus: Total marketable securities of the two companies (pre-merger)

____________

___________

___________



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Feasibility Analysis: Acquisition for Stock

Steps for acquiring a Target Company Stock

Estimation of value of acquirer's shares

Computation of maximum number of shares which acquirer

can exchange to acquire target company under different scenarios and at minimum acceptable

rates of return

Evaluation of the impact of the acquisition on the earnings per share and capital structure of the

acquirer

Click here to a solve a problem on Acquisition

for Stock



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Fair Value: Institutional Criterion

All-India level financial institutions and banks follow the following criteria for calculating the fair value.

Past Records of Company

The fair price is worked out on the basis of the track record of the

company

Break-up Value

The break-up value of the equity shares may be arrived at having

regard to the assets and liabilities of the company

Earnings Capacity Value

Average earnings and yield rate and capitalisation of earnings are

considered

Market Price

Market expectations regarding dividend and capital appreciation are important in determining the share

price.

BASIS FOR ARRIVING AT FAIR PRICE

Click here for a detailed explanation of the factors to be considered for

arriving at a fair price



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Acquisition of Sick Companies: Historical Case

• Let us consider a case of the tax-based financial synergy.

• The case of Mahindra and Mahindra Ltd. with Mahindra Spicer Ltd. is a typical example, though certainly not the only one.

Click here for a detailed case of merger on Mahindra and Mahindra

Ltd with Mahindra Spicer Ltd



Summary

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• The valuation of a target company is very important in an acquisition.

• Companies use different approaches to do the valuation, including present value analysis and capital assets analysis.

• While fixing the price for acquisition, the acquiring company should consider the key factors like market price of the shares, DPR, PER, debt equity ratio and NAV.

• The acquisition can be by way of cash or stock.

• In cash transactions, the acquirer company's shareholders equity remains unchanged.

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Glossary

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• CAPM: Capital Asset Pricing Model

• DPR: The percentage of earnings paid to shareholders in dividends.

• NAV: The market value of all securities owned by a mutual fund, minus its total liabilities, divided by the number of shares issued.

• Breakup value: The sum-of-parts value of a publicly traded company.

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Check Your Learning

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1. The basic purpose of valuation of a target company is to locate the possibilities of _________________.

2. Under present value analysis the theoretical market value is compared with the ______________ to determine the net present value on investments.

3. Under _______________ model if expected rate of return exceeds the required rate of return then it is a good buy.

4. A takeover generally involves the acquisition of a certain block of _____________ of the company.

5. In share exchange mergers the shareholders of the target company become shareholders in the combined enterprise. (True/False)

6. Share exchange ratio is generally determined by the relative bargaining strengths of the companies. (True/False)

7. Company with lower PER shows a record of high growth in earnings per share. (True/False)

8. In ________________ the acquirer company's shareholders’ equity remains unchanged.

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Check Your Learning

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9. Post-merger debt capacity is assessed by multiplying acquirer's equity by targeted ______________________.

10.Market expectations regarding dividend and capital appreciation are important factors in determining the __________________.

11.__________________ are excluded in calculating the breakup value of equity shares.

12.The elements considered for fair price are the breakup value per share, notational value based on earning and the __________________.

13.The expectations of _________________ would vary from time to time.



Answers

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1. Takeover.

2. Actual market price.

3. CAPM.

4. Equity capital.

5. True.

6. True.

7. False.

8. Cash transactions.

9. Debt equity ratio.

10.Share price.

11.Intangible assets.

12.Market value per share.

13.Yield.

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Case Study

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Answer the following questions, based on the given case: Question Discuss the benefits and losses of the overseas acquisition. Hint answer: In overseas acquisition, a company can find the other markets to sell its products. In the case mentioned above, Dhunseri is exploring the overseas opportunities due to labour shortage and local regulations.

Click on the icon besides, to analyse the case on Strategic

Evaluation of Mergers and Acquisitions

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