Mergers & Acquisition

Mergers & Acquisition Acquisition also known as Takeover is the buying of one company( the target) by another ( the acquirer) Can be friendly – through negotiation and consent or Hostile (Black Knight)- through creeping acquisition (Dawn raids) When a smaller company acquires management control over a bigger company it is referred as “ Reverse Takeover”

Mergers & AcquisitionTypes of Acquisitions • The buyer buys the Shares and therefore the control of the target company, with all liabilities and risks( tax neutral) • The buyer buys the Assets by “ cheery picking”. The cash received by the Target company is paid to their shareholders as dividend or through liquidation settlement. (has tax implications)

Mergers & Acquisition • Merger is a combination of two companies into one larger company. • Involve Stock swap or Cash payment • May result in a new company name/new branding. • The term merger is used as it is softer than acquisition sometimes.

Mergers & AcquisitionClassification of Mergers • Horizontal Merger:- where two merging companies produce similar products in the same industry. • Vertical Merger:- when two firms each working at different stages in the production of the same goods, combine. • Congeneric Mergers:-where two merging firms are in the same general industry, but they have no mutual buyer/customer or supplier relationships, such as a merger between a bank and a leasing company. • Conglomerate Mergers:- take place when the two firms operate in different industries. • Reverse Merger: - When a bigger company merges with a smaller company it is referred as “ Reverse Merger”

Mergers & Acquisition Classification of Mergers • Accretive Mergers:- When an acquiring company's EPS increases. • Dilutive Mergers- When an acquiring company's EPS decreases.

Mergers & AcquisitionIs it always a success story ? • Very often results in a net loss of Value due to:- • Incompatibility of technology, equipments, corporate culture. • Inadequate research or concealment of losses or liabilities. • Overlapping subsidiaries or redundant staff • Disrupting employee culture/confidence. A successful merger is one which increases shareholder value faster or prevents deterioration in Value.

Mergers & AcquisitionFinancing M & A • By Cash payments:- target comes under indirect control of the bidders shareholders alone. Makes sense in market with down trends in interest rates. This has lesser chances of EPS dilution for the acquiring company, but strains cash flows. • By Issue of Bonds • By Leveraged Buy-out • By Hybrid financing. • By deferred payment plan. • By MBO from owners.

Mergers & Acquisition • Motives behind Mergers which addshareholders value:- • Economies of scale. • Increased revenue/increased market share • Cross selling • Synergy- use of complementary resources • Tax benefits • Geographical and other diversification • Resource transfer

Mergers & Acquisition • Motives behind Mergers which do not add value :- • Diversification – Management issues • Manager’s overconfidence on expectations- higher payments. • Empire Building syndrome • Manager’s compensation- % of profits or profit per share ? • Vertical Integration-cheaper costs/lower revenue. Competitors reluctance to supply.

Mergers & Acquisition • Financial synergies gained by merger are:- • Better credit worthiness • Reduction in cost of capital • Increase in debt capacity • Increase in P/E ratio and value per share. • Low floatation cost. • Better access to capital. • Sometimes demergers, spin-offs, spin-outs splits companies into two, generating a second company separately listed in stock exchange to unlock values.

Mechanics of Merger- Legal Procedure • Examination of Object Clauses • Intimation to Stock Exchanges • Approval of the Draft Amalgamation Proposal by the respective boards • Application to the High Court • Dispatch of Notice to Shareholders and Creditors • Holding of Meetings of Shareholders and Creditors • Petition to the court for confirmation and passing of court orders • Filing the order with the Registrar • Transfers of Assets and Liabilities • Issue of Shares and Debentures

Amalgamation in the nature of Merger- Conditions to be met All assets and liabilities of transferor company should become the assets and liabilities of transferee company. Shareholders holding not less than 90% of the face value of shares of the transferor company should become the shareholders of the transferee company. Consideration to be paid by transferee company by way of equity shares. Cash can be paid to dissenting shareholders. Business of the transferor company is intended to be carried on by transferee company. Transferee company to incorporate in its Balance sheet the book values of, assets & liabilities of the transferor company ( including reserves & profits) with changes only for change in accounting policies. IF ABOVE CONDITIONS NOT SATISIFIED IT IS AN “ ACQUISITION” and not a “ MERGER”

Amalgamation in the nature of Acquisition -Purchase- Conditions to be met • Assets and outside liabilities of transferor company carried at their fair market values. • The difference between purchase consideration and value is treated as “ Goodwill and amortized over 5 years. If the difference is negative treat as “ Capital Reserve”. • Due to higher write up of assets, leading to higher depreciation and amortization of goodwill, profits under this method are lower. • In this method Reserves and Profits of transferor company are not merged in the Balance Sheet.

Methods of accounting for mergers? • Pooling of interests Method: • Assumes a merger among equals. • New balance sheet is merely the sum of the two existing balance sheets. • No income statement effects other than summing the two income statements. (P&L) • Difference between share capital issued to transferor company and the amount of share capital of transferor company is adjusted to General Reserves.

Purchase Method : • The assets of the acquired firm are “written up” to reflect purchase price if it is greater than the net asset value. • Goodwill is often created, which appears as an asset on the balance sheet. • Common equity account is increased to balance assets and claims. • Goodwill is amortized and expensed over time, thus reducing future reported earnings. • If any special Reserve is to be carried forward for more years, create Amalgamation Adjustment Account( Dr.) and maintain the Reserve. • Balances in P & L account and General Reserves a/c will no more exist as cash purchase consideration is made.

PROCEDURE FOR MERGERS:- • Appointment of the merchant banker – Acquirer has to appoint category 1 merchant banker. • Public announcement of the offer- 1) Merchant Banker would make announcement within 4 days from the decision to acquire shares. 2) Public announcement in one English, one Hindi and one regional language daily. 3) Notification should be sent to concerned stock exchanges and to the target company.

Submission of letter of offer to SEBI-The MB should file with SEBI the draft of the letter of offer with the fees of Rs. 50,000/-within 14 days from the date of public announcement. • Minimum Offer Price-It would be payable a)In Cash and/or b)By exchange of shares of the acquirer if it is a listed co. c) By exchange and/or transfer of secured instruments with a minimum of ‘A ’grade rating from the credit rating agencies. d)A combination of all of three.

Minimum offer price - It should be highest of (a)Negotiated price (b)Highest price paid by the acquirer during the 26 weeks prior to the date of announcement. (c)price paid by acquirer under preferential allotment. (d)Average of the quoted weekly high and low of the closing prices of the shares of the target co. during 26 weeks preceding the date of public announcement.

Minimum no. of shares to be acquired- It should be made for minimum of 20% of the voting capital. General obligations of the acquirer 1. The acquirer should send the copy of the draft letter to the target co. 2.To send the letter of offer to all the shareholders of the target co. 3.To send the letter of offer to the custodians of ADR/GDR holders. 4.The offer should remain open for the period of maximum 30days. 5.During the offer period the acquirer should not enter the board of directors of the target co. 6Acquirer should complete all the procedures within 3o days from the date of closure.

General obligations of the target co. 1.During the offer period, the target co. should not sell, transfer, and dispose off its assets in the ordinary course of business of the co. 2.He should not issue any authorized but not issued securities. 3.The target co. should furnish a list of shareholders, warrant holders, convertible debenture holders to the Acquirer. 4.After the announcement of public offer, the board of director should not appoint any person as an additional director. 5.Upon fulfillment of the obligations by the acquirer, the board of directors would transfer the acquired securities and give representation on the board or control over the co.

SEBI substantial acquisition of shares and takeover code, 1997 • Acquisition of shares / voting right- Acquirer holding 5% of voting rights is required to disclose to the concerned Co. Continual Disclosure- Persons holding more than 15 % have to disclose their holdings within 21 days from the financial year-end to the respective co. • Power to call information- Stock exchanges.Concerned co. would have to furnish disclosures of shareholding. • Acquisition of 15 % or more shares-Acquirer has to make public announcement at this stage.

Contents of the public announcement offer- • Existing paid up share capital of the target co. • Total no. of shares proposed to be acquired from public. • Minimum offer price. • Identity of the acquirer. • Existing holdings of the acquirer in the target company. • The average and the highest price paid by the acquirer for acquisitions. • Objective and purpose of acquisition, future plans • The date of opening and closure of the offer. • Whether the offer is subject to minimum no of shares from the shareholders. • Mode of payment of consideration.

Competitive bid • Any person within the 21 days from the public announcement should make the public announcement of his offer for acquisition of the shares of the same target co. • Such offer should be at least equal to the no. of shares for which the first announcement has been made. • The first acquirer would (a) Revise the offer (b) Withdraw the offer. • Upward revision of offer- Irrespective of the competitive bid it can be done any time up to 7 working days prior to the closing of the issue. • Withdrawal of offer- 1.As a consequence of competitive bid. 2.The statutory approval required has been refused 3.Sole acquirer has died.

DIVESTITURES • Mergers, Amalgamations, takeovers, acquisitions- bring ‘synergy’- 3 + 2=6!! • Divestitures bring ‘Energy’- 5-3 =3 !! • Types of Divestitures:- • Partial Sell-off- of Divisions • If Div. Proceeds > Value of ownership position(VOP) • If Div. Proceeds = VOP – decision may be indifferent • If Div. Proceeds < VOP – Retain holding. Referred as “ Slump Sale” attracts Capital Gains.

DIVESTITURES • Types of divestitures (contd):- • Demergers:- • Spin- off:- of a division into an independent company( cash disbursed to shareholders of existing co.) • Split-up:- when company splits into one or more companies • Equity Carve-out:- Parent co. selling a portion of its equity in a subsidiary to public for CASH. Strategic investor may get inducted into the subsidiary.

Ownership restructuring • Going Private:- • Private-Public Partnership • Leveraged Buy-out

Mergers & Acquisition