Professional Documents
Culture Documents
MF0002
MERGERS & ACQUISITIONS
Types of Merger:
Petroleum Exploration
Backward Linkage
Ans: Mergers and acquisitions are transactions of great significance not only to the
companies themselves but also to many other constituencies such as workers, managers,
competitor communities and economies. Hence, the mergers and acquisition process
needs to be viewed as a multi-stage process with each stage giving rise to distinct
problems and challenges to companies understating such transactions. To understand the
nature and sources of these problems we need a good understanding of the external
context in which merger and acquisition take place. This context is not purely economic
but includes political, sociological and technological contexts as well. The context is also
ever changing. Thus merger and acquisition could be regarded as a dynamic response to
these changes.
The five stage model conceptualizes the merger and acquisition process as being driven
by a variety of impulses, not all of them reducible to rational economic paradigms. Both
economic and non-economic factors affect the merger and acquisition process. The five
stages of merger and acquisition process under 5-S model can be divided as below:
a. Spin off:
The creation of an independent company is through the sale or distribution of new shares
of an existing business / division of a parent company. It is a kind of de-merger when an
existing parent company transforms into two or more separately re-organized different
entity. The parent company distributes all the shares it owns in a controlled subsidiary to
its own shareholder on a pro-rata basis. In this process, the parent company gains effect
to making two of the one company. It may be in the form of subsidiary or a separate
company. There is no money transaction in spin off. The transaction is treated as stock
dividend and tax free exchange. Both companies exist and carry on business. It does not
alter ownership proportion in any company. The newly created entity becomes an
independent company taking its own decision and developing its own policies and
strategies, which need not necessarily, be the same as those of the parent company. Spin-
off is necessary for a company having brand equity or multi-product company enters into
collaboration with a foreign company. Businesses wishing to ‘streamline’ their operations
often sell less productive or unrelated subsidiary businesses as spin-offs. The spun-off
companies are expected to be worth more as independent entities than as parts of a larger
business.
Businesses wishing to ‘streamline’ their operations often sell less productive or unrelated
subsidiary businesses as spin-offs. The spun-off companies are expected to be worth
more as independent entities than as parts of a large business.
More and more companies are using equity carve-outs to boost shareholder value.
A carve-out is a strategic avenue a parent firm may take when one of its subsidiaries is
growing faster and carrying higher valuations than other businesses owned by the parent.
A carve-out generates cash because shares in the subsidiary are sold to the public, but the
issue also unlocks the value of the subsidiary unit and enhances the parent’s shareholder
value. The new legal entity of a carve-out has a separate board, but in most carve-outs,
the parent retains some control. In these cases, some portion of the parent firm’s board of
directors may be shared. Since the parent has a controlling stake, meaning both firms
have common shareholders, the connection between the two will likely be strong.
That said, sometimes companies carve-out a subsidiary not because it’s doing well, but
because it is a burden. Such an intention won’t lead to a successful result, especially if a
carved-out subsidiary is too loaded with debt or had trouble even when it was a part of
the parent and is lacking an established track record for growing revenues and profits.
Carve-outs can also create unexpected friction between the parent and subsidiary.
Problems can arise as managers of the carved-out company should be accountable to their
public shareholders as well as the owners of the parent company. This can create divided
loyalties.
Leveraged buy outs are risky for the buyers if the purchase is highly leveraged. An LBO
can be protected from volatile interest rates by an Interest Rate Swap, locking in a fixed
interest rate, or an interest rate Cap which prevents the borrowing cost from rising above
a certain level. LBO’s also have been financed with high yield debt or Junk Bonds and
have also been done with the interest rate capped at a fixed level and interest costs above
the cap added to the principal. For commercial banks, LBO’s are attractive because these
financings have large up-front fees. They also fill the gap in corporate lending created,
when large corporations begin using commercial paper and corporate bonds in place of
bank loans.
In a LBO, there is usually a ratio of 90% debt to 10% equity. Because of this debt-equity
ratio, the bonds usually are not investment grade and are referred to as junk bonds. In
1980 several prominent buyouts led to the eventual bankruptcy of the acquired
companies. This was mainly due to the fact that the leverage ratio was nearly 100% and
the interest payments were so large that the company’s operating cash flows were unable
to meet the obligation. In the US, specialized LBO firms provide finance for acquisition
against target company’s assets or cash flows.
d. Concentric Mergers:
It is a combination of firms related to each other in terms of customer groups or customer
functions or alternative technologies. For example, combination of firms producing
television, washing machines and kitchen appliances come under the concept concentric
merger. The important benefits of concentric mergers are:
Reducing of Risks
Economies of large scale operations
Financial stability
Increase in profit
Attain managerial competence
There are two types of partners in this type of partnership. They are called as general
partners and limited partners. The general partner is the party responsible for managing
the business and bears unlimited liability. The general partner is typically the sponsor
corporation or one of its operating subsidiaries. General partner receives compensation
that is linked to the performance of the venture and is responsible for the operations pf
the company and, in most cases, is liable for partnership debt. The limited partner is the
person or group (retail investors) that provides the capital to the MLP and receives
periodic income distributions from the MLPs cash flow. The limited partners have no
day-to-day management role in the partnership.
It has the advantage of limited liability for the limited partners. The transferability
provides for continuity of life. MLP is not treated as an entity, it is treated as partnership
for which income is allocated pro-rata to the partners. The advantage of MLPs is the
combination of the tax benefits of a limited partnership with the liquidity of a publicly
traded company.
MLPs allow for pass-through income, meaning that they are not subject to corporate
income taxes. The partnership does not pay taxes from the profit – the money is only
taxed when unit holders receive distributions. The owners of an MLP are personally
responsible for paying taxes on their individual portions of the MLP’s income, gains,
losses, and deductions. This eliminates the ‘double taxation’ generally applied to
corporations (whereby the corporation pays taxes on its income and the corporation’s
shareholders also pay taxes on the corporation’s dividends). That is, MLP is taxed as
partnership avoids double taxation and the business achieves a lower effective tax rate.
The lower cost of capital resulting from the reduced effective tax rate provides the
partnership with a competitive advantage when vying against corporations during
competitive asset sales or bidding wars and can ultimately provide a higher return to unit
holders.
Roll Up MLP – Formed by the combination of two or more partnership into one publicly
traded partnership.
Acquisition MLPs – Formed by an offering of MLP interest to the public with the
proceeds used to purchase assets.
Start Up MLP – Formed by partnership that is initially privately held but later offers its
interests to the public in order to finance internal growth.
4. Case Study
(Rs. In Lakhs)
Fixed Assets:
Plant & Machinery 250
Furniture & Fittings 5 255
Current Assets:
Inventories 90
Debtors 25
Bank Balance 10 125
Total 380
2. Mode of Payment:
3. Calculation of present value of expected benefits:
Ans: The most difficult part of merger or acquisition is the integration of the acquired
company into the acquiring company. The difficulty of integration also depends on the
degree of control desired by the acquirer. The post-merger and acquisition integration of
the firm is a crucial task to be accomplished for effective performance. The post-merger
integration process starts after the successful deal of merger. Extent of integration is
defined by the need to maintain the separateness of the acquired business.
Integration Planning:
The success of an integration process depends upon the role of acquisition and the nature
of managers involved in the transaction and implementation. The process of integration
itself has to be planned so that the acquired or merged company integrates smoothly.
Therefore, merger and acquisition requires a detailed planning for integration as given
below:
• Integration Plan:
Once the merger or acquisition took place, the acquiring company should prepare a
detailed strategic plan for integration based on its own and the target company’s strength
and weakness.
• Communication:
The plan of integration should be communicated to all employees and also their
involvement in making integration smooth and easy and remove any ambiguity or fear in
the minds of the staff.
• Cultural integration:
Management should focus the culture integration of the employees. A proper
understanding of culture of two organizations, clear communication and training can help
to bridge the cultural gaps.
• Structural Adjustments:
The acquired company may design the new organization structure and redefine the roles,
authorities and responsibilities of the employees.
• Control System:
It is to ensure that it is in control of all resources and activities of the merged entity. It
must put proper financial control in place so that resources are optimally utilized and
wastages is avoided.
Ans: The consideration for the amalgamation may consist of securities, cash or other
assets. In determining the value of the consideration, an assessment is made of the fair
value of its elements. A variety of techniques are applied in arriving at fair value. For
example, when the consideration includes securities, the value fixed by the statutory
authorities may be taken to be the fair value. In case of other assets, the fair value may be
determined by reference to the market value of the assets given up. Where the market
value of the assets given up cannot be reliably assessed, such assets may be valued at
their respective net book values.
• Lump-sum Method:
When the acquiring company agrees to pay a lump-sum amount to the target company, it
is called lump-sum payment of purchase consideration.
• Payment Method:
Under this method, all payments made by the acquiring company to the acquired
company are added.
Cash xxx
Shares xxx
Debentures xxx
Liquidation Expenses xxx
Purchase consideration XXX
In this case, the value of assets and liabilities taken over by the purchasing company need
not be taken into account. Only payments are to be added to arrive at the amount pf
purchase consideration.
a. White Square:
The White Square is a modified form of a white knight. The difference being that the
white square does not acquire control of the target. In a white square transaction, the
target sells a block of its stock to a third party it considers to be friendly. The white
square sometimes is required to vote its shares with the target management. These
transactions often are accompanied by a stand-still agreement that limits the amount of
additional target stock the white square can purchase for a specified period of time and
restricts the sale of its target stock, usually giving the right of first refusal to the target. In
return, the white square often receives a seat on the target board, generous dividends,
and / or a discount on the target shares. Preferred stock enables the board to tailor the
characteristics of that stock to fit the transaction and so usually is used in white square
transaction.
b. Crown Jewel:
When a target company uses the tactics of divestiture, it is said to sell the “Crown Jewel”.
The precious assets in the company are called “Crown Jewel” to depict the greed of the
acquirer under the takeover bid. These precious assets attract the rider to bid for the
company’s control. The company as a defense strategy, in its own interest, sells these
valuable assets at its own initiative leaving the rest of the company intact. Instead of
selling these valuable assets, the company may also lease them or mortgage them to
creditors so that the attraction of free assets to the predator is over. As per SEBI takeover
regulation, the above defense can be used only before the predator makes public
announcement of its intention to takeover the target company.
c. Poison Pill:
Poison pills represent the creation of securities carrying special rights exercisable by a
triggering event. The triggering event could be the accumulation of a specified
percentage of target shares or the announcement of a tender offer. The special rights may
take many forms but they all make it costlier to acquire control of the target firm. As a
tactical strategy, the target company might issue convertible securities, which are
converted into equity to deter the efforts pf the offer, or because such conversion dilutes
the bidders shares and discourages acquisition. Another example, Target company might
rise borrowing distorting normal Debt to Equity ratio. Poison pills can be adopted by the
board of directors without shareholder approval. Although not required, directors often
will submit poison pill adoptions to shareholders for ratification.
d. Staggered Board:
A staggered board of directors (also known as a classified board) is a board that is made
up of different classes of directors. Usually, there are three classes, with each class
serving for a different term length than the other. Elections for the directors of staggered
boards usually happen on an annual basis. At each election, shareholders are asked to
vote to fill whatever positions of the board are vacant, or up for re-election. Terms of
service for elected directors vary, but one-, three- and five-year terms are common.
Information on corporate governance policies and board composition can be found in
a public company's proxy statement. Generally, proponents of staggered boards sight two
main advantages that staggered boards have over traditionally elected boards: board
continuity and anti-takeover provisions - hostile acquirers have a difficult time gaining
control of companies with staggered boards. Opponents of staggered boards,
however, argue that they are less accountable to shareholders than annually elected
boards and that staggering board terms tends to breed a fraternal atmosphere inside the
boardroom that serves to protect the interests of management above those of shareholders