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Q.1 What are the cultural aspects involved in a merger. Give sufficient examples. Answer: The value chains of the acquirer and the acquired, need to be integrated in order to achieve the value creation objectives of the acquirer. This integration process has three dimensions: the technical, political and cultural. The technical integration is similar to the capability transfer discussed above. The integration of social interaction and political relationships represents the informal processes and systems which influence peoples ability and motivation to perform. At the time of integration, the acquirer should have regard to these political relationships, if acquired employees are not to feel unfairly treated. An important aspect of integration is the cultural integration of the acquiring and acquired firms. The culture of an organization is embodied in its collective value systems, beliefs, norms, ideologies myths and rituals. They can motivate people and can become valuable sources of efficiency and effectiveness. The following are the illustrative organizational diverse cultures which may have to be integrated during post-merger period: Strong top leadership versus Team approach Management by formal paper work versus management by wandering around Individual decision versus group consensus decision Rapid evaluation based on performance versus Long term relationship based on loyalty Rapid feedback for changes versus formal bureaucratic rules and procedures Narrow career path versus movement through many areas Risk taking encouraged versus one mistake you are out Risky activities versus low risk activities Narrow responsibility arrangement versus Everyone in this company is salesman (or cost controller, or product quality improver etc.) Learn from customer versus We know what is best for the customer the above illustrative culture may provide basis for the classification of organizational culture. There are four different types of organizational culture as mentioned below: Power - The main characteristics are: essentially autocratic and suppressive of challenge; emphasis on individual rather than group decision making Role- The important features are: bureaucratic and hierarchical; emphasis on formal rules and procedures; values fast, efficient and standardized culture service Task/achievement- The main characteristics are: emphasis on team commitment; task determines organization of work; flexibility and worker autonomy; needs creative environment Person/support- The important features are: emphasis on equality; seeks to nurture personal development of individual members Poor cultural fit or incompatibility is likely to result in considerable fragmentation, uncertainty and cultural ambiguity, which may be experienced as stressful by organizational members. Such
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stressful experience may lead to their loss of morale, loss of commitment, confusion and hopelessness and may have a dysfunctional impact on organizational performance. Mergers between certain types can be disastrous. Differences in culture may lead to polarization, negative evaluation of counterparts, anxiety and ethnocentrism between top management teams of the acquired and acquiring firms. In assessing the advisability of an acquisition, the acquirer must consider cultural risk in addition to strategic issues. The differences between the national and the organizational culture influence the cross-border acquisition integration. Thus, merging firms must consciously and proactively seek to transform the cultures of their organizations.

Q.2 What are the sources of operating synergy? Answer: Sources of Operating Synergy Operating synergies are those synergies that allow firms to increase their operating income, increase growth or both. We would categorize operating synergies into four types: 1. Economies of scale that may arise from the merger, allowing the combined firm to become more cost-efficient and profitable. Economics of scales can be seen in mergers of firms in the same business For example: two banks combining together to create a larger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. Both the banks after combination can expect to cut costs considerably on account of sharing of their resources and thus avoiding duplication of facilities available. 2. Greater pricing power from reduced competition and higher market share, which should result in higher margins and operating income. This synergy is also more likely to show up in mergers of firms which are in the same line of business and should be more likely to yield benefits when there are relatively few firms in the business. When there are more firms in the industry ability of firms to exercise relatively higher price reduces and in such a situation the synergy does not seem to work as desired. An example of limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. The two companies were in the same line of business and were in direct competition with each other leading to a severe price war and increased marketing costs. After the acquisition blow past acquired a strong hold on the market and operated under near monopoly situation. Another example is the acquisition of Tomco by Hindustan Lever. 3. Combination of different functional strengths, combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. The phenomenon can be understood in cases where one company with an established brand name lends its reputation to a company with upcoming product line or a company. A company with strong distribution network merges with a firm that has products of great potential but is unable to reach the market before its competitors can do so. In other words the two companies should get the advantage of the combination of their complimentary functional strengths.

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4. Higher growth in new or existing markets, arising from the combination of the two firms. This would be case when a US consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products. Operating synergies can affect margins and growth, and through these the value of the firms involved in the merger or acquisition. Synergy results from complementary activities. This can be understood with the following example Example: Consider a situation where there are two firms A and B. Firm A is having substantial amount of financial resources (having enough surplus cash that can be invested somewhere) while firm B is having profitable investment opportunities (but is lacking surplus cash). If A and B combine with each other both can utilize each other strengths, for example here A can invest its resource in the opportunities available to B. note that this can happen only when the two firms are combined with each other or in other words they must act in a way as if they are one.

Q.3 Explain the process of a leveraged buyout? Answer: In the realm of increased globalized economy, mergers and acquisitions have assumed significant importance both with the country as well as across the boarders. Such acquisitions need huge amount of finance to be provided. In search of an ideal mechanism to finance and acquisition, the concept of Leverage Buyout (LBO) has emerged. LBO is a financing technique of purchasing a private company with the help of borrowed or debt capital. The leveraged buyout are cash transactions in nature where cash is borrowed by the acquiring firm and the debt financing represents 50% or more of the purchase price. Generally the tangible assets of the target company are used as the collateral security for the loans borrowed by acquiring firm in order to finance the acquisition. Sometimes, a proportionate amount of the long term financing is secured with the fixed assets of the firm and in order to raise the balance amount of the total purchase price, unrated or low rated debt known as junk bond financing is utilized. Modes of purchase There are a number of types of financing which can be used in an LBO. These include: Senior debt: this is the debt which ranks ahead of all other debt and equity capital in the business. Bank loans are typically structured in up to three trenches : A, B and C. The debt is usually secured on specific assets of the company, which means the lender can automatically acquire these assets if the company breaches its obligations under the relevant loan agreement; therefore it has the lowest cost of debt. These obligations are usually quite stringent. The bank loans are usually held by a syndicate of banks and specialized funds. Typically, the terms of senior debt in an LBO will require repayment of the debt in equal annual installments over a period of approximately 7 years. Subordinated debt: This debt ranks behind senior debt in order of priority on any liquidation. The terms of the subordinated debt are usually less stringent than senior debt. Repayment is usually required in one bullet payment at the end of the term. Since subordinated debt gives the lender less security than senior debt, lending costs are typically higher. An increasingly important form of subordinated debt is the high yield bond, often listed on Indian markets. High
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yield bonds can either be senior or subordinated securities that are publicly placed with institutional investors. They are fixed rate, publicly traded, long term securities with a looser covenant package than senior debt though they are subject to stringent reporting requirements. Mezzanine finance: This is usually high risk subordinated debt and is regarded as a type of intermediate financing between debt and equity and an alternative of high yield bonds. An enhanced return is made available to lenders by the grant of an equity kicker which crystallizes upon an exit. A form of this is called a PIK, which reflects interest paid in kind, or rolled up into the principal, and generally includes an attached equity warrant. Loan stock: This can be a form of equity financing if it is convertible into equity capital. The question of whether loan stock is tax deductible should be investigated thoroughly with the companys advisers. Preference share: This forms part of a companys share capital and usually gives preference shareholders a fixed dividend and fixed share of the companys equity. Ordinary shares: This is the riskiest part of a LBOs capital structure. However, ordinary shareholders will enjoy majority of the upside if the company is successful.

Q.4 What are the basic steps in strategic planning for a merger? Answer: Basic steps in Strategic planning in Merger: Any merger and acquisition involve the following critical activities in strategic planning processes. Some of the essential elements in strategic planning processes of mergers and acquisitions are as listed here below: 1. Assessment of changes in the organization environment 2. Evaluation of company capacities and limitations 3. Assessment of expectations of stakeholders 4. Analysis of company, competitors, industry, domestic economy and international economies 5. Formulation of the missions, goals and polices 6. Development of sensitivity to critical external environmental changes 7. Formulation of internal organizational performance measurements 8. Formulation of long range strategy programs 9. Formulation of mid-range programmes and short-run plans 10. Organization, funding and other methods to implement all of the proceeding elements 11. Information flow and feedback system for continued repetition of all essential elements and for adjustment and changes at each stage 12. Review and evaluation of all the processes In each of these activities, staff and line personnel have important Responsibilities in the strategic decision making processes. The scope of mergers and acquisition set the tone for the nature of mergers and acquisition activities and in turn affects the factors which have significant influence over these activities. This can be seen by observing the factors considered during the
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different stages of mergers and acquisition activities. Proper identification of different phases and related activities smoothen the process of involved in merger.

Q.5 Study a recent merger that you have read about and discuss the synergies that resulted from the merger. Answer: Synergy is the additional value that is generated by the combination of two or more than two firms creating opportunities that would not be available to the firms independently. There are two main types of synergy: 1. Operating synergy 2. Financial synergy Operating Synergy Operating synergies are those synergies that allow firms to increase their operating income, increase growth or both. We would categorize operating synergies into four types: 1. Economies of scale that may arise from the merger, allowing the combined firm to become more cost-efficient and profitable. Economics of scales can be seen in mergers of firms in the same business For example: two banks combining together to create a larger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. Both the banks after combination can expect to cut costs considerably on account of sharing of their resources and thus avoiding duplication of facilities available. 2. Greater pricing power from reduced competition and higher market share, which should result in higher margins and operating income. This synergy is also more likely to show up in mergers of firms which are in the same line of business and should be more likely to yield benefits when there are relatively few firms in the business. When there are more firms in the industry ability of firms to exercise relatively higher price reduces and in such a situation the synergy does not seem to work as desired. An example of limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. The two companies were in the same line of business and were in direct competition with each other leading to a severe price war and increased marketing costs. After the acquisition blow past acquired a strong hold on the market and operated under near monopoly situation. Another example is the acquisition of Tomco by Hindustan Lever. 3. Combination of different functional strengths, combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. The phenomenon can be understood in cases where one company with an established brand name lends its reputation to a company with upcoming product line or a company. A company with strong distribution network merges with a firm that has products of great potential but is unable to reach the market before its competitors can do so. In other words the two companies should get the advantage of the combination of their complimentary functional strengths.
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4. Higher growth in new or existing markets, arising from the combination of the two firms. This would be case when a US consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products. Operating synergies can affect margins and growth, and through these the value of the firms involved in the merger or acquisition. Synergy results from complementary activities. This can be understood with the following example Example: Consider a situation where there are two firms A and B. Firm A is having substantial amount of financial resources (having enough surplus cash that can be invested somewhere) while firm B is having profitable investment opportunities (but is lacking surplus cash). If A and B combine with each other both can utilize each other strengths, for example here A can invest its resource in the opportunities available to B. note that this can happen only when the two firms are combined with each other or in other words they must act in a way as if they are one. Financial Synergy With financial synergies, the payoff can take the form of either higher cash flows or a lower cost of capital (discount rate). Included are the following: A combination of a firm with excess cash, or cash slack, (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm. The increase in value comes from the projects that were taken with the excess cash that otherwise would not have been taken. This synergy is likely to show up most often when large firms acquire smaller firms, or when publicly traded firms acquire private businesses. Debt capacity can increase, because when two firms combine, their earnings and cash flows may become more stable and predictable. This, in turn, allows them to borrow more than they could have as individual entities, which creates a tax benefit for the combined firm. This tax benefit can either be shown as higher cash flows, or take the form of a lower cost of capital for the combined firm. Tax benefits can arise either from the acquisition taking advantage of tax laws or from the use of net operating losses to shelter income. Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden. Alternatively, a firm that is able to increase its depreciation charges after an acquisition will save in taxes, and increase its value. Clearly, there is potential for synergy in many mergers. The more important issues are whether that synergy can be valued and, if so, how to value it. This result has to be interpreted with caution, however, since the increase in the value of the combined firm after a merger is also consistent with a number of other hypotheses explaining acquisitions, including under valuation and a change in corporate control. It is thus a weak test of the synergy hypothesis. The existence of synergy generally implies that the combined firm will become more profitable or grow at a faster rate after the merger than will the firms operating separately. A stronger test of synergy is to evaluate whether merged firms improve their performance (profitability and growth) relative to their competitors, after takeovers. On this test, as we show later in this chapter, many mergers fail.

Q.6 What are the motives for a joint venture, explain with an example of a joint venture.
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Answer: As there are good business and accounting reasons to create a joint venture with a company that has complementary capabilities and resources, such as distribution channels, technology, or finance, joint ventures are becoming an increasingly common way for companies to form strategic alliances. In a joint venture, two or more parent companies agree to share capital, technology, human resources, risks and rewards in a formation of a new entity under shared control. Broadly, the important reasons for forming a joint venture can be presented below: Internal Reasons to Form a JV Spreading Costs: You and a JV partner can share costs associated with marketing, product development, and other expenses, reducing your financial burden. Opening Access to Financial Resources: Together you and a JV partner might have better credit or more assets to access bigger resources for loans and grants than you could obtain on your own. Connection to Technological Resources: You might want access to technological resources you couldn't afford on your own, or vice versa. Sharing innovative and proprietary technology can improve products, as well as your own understanding of technological processes. Improving Access to New Markets: You and a JV partner can combine customer contacts and together even form a joint product that accesses new markets. Help Economies of Scale: Together you and a JV partner can develop products or services that reduce total overall production expenses. Bring your product to market cheaper where the customer can enjoy the cost savings.

External Reasons to Form a JV Develop Stronger Innovative Product: Together you and a JV partner may be able to share ideas to develop a product that is more competitive in your industry. Improve Speed to Market: With shared access to financial, technological, and distribution resources, you and a JV partner can get your joint product to market faster and more efficiently. Strategic Move Against Competition: A JV may be able to better compete against another industry leader through the combination of markets, technology, and innovation. Strategic Reasons Synergistic Reasons: You may find a JV partner with whom you can create synergy, which produces a greater result together than doing it on your own. Share and Improve Technology and Skills: Two innovative companies can share technology to improve upon each other's ideas and skills. Diversification - There could be many diversification reasons: access to diverse markets, development of diverse products, diversify the innovative working force, etc. Don't let a JV opportunity pass you by because you don't think it will fit in with your own small business. Small and big companies alike can benefit from the reasons listed above. Analyze how

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your company can benefit internally, externally, and strategically, and then find a joint venture partner that will fit with your needs.

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SET - 2
Q.1 List out the defense strategies in the face of a hostile takeover bid. Answer: Raid Techniques Techniques used in raids are such as Techniques of raid takeover bid and tender offer. The procedure for organizing takeovers includes collection of relevant information and its analysis, examine shareholders' profile, investigation of title and searches into indebtedness, examining of articles of association etc,. Defence against takeover bid may be in the form of advance preventive measures for defence such as - joint holdings or joint voting agreement, interlocking shareholdings or cross shareholdings, issue of block of shares to friends and associates, defensive merger apart from other things. Tactical defence' strategies include friendly purchase of shares, emotional attachment, loyalty and patriotism, recourse to legal action, operation White Knights', "Golden Parachutes" etc,. Four basic tactics or schemes can be carved out when we study the practice of corporate raiding which are bankruptcy, corporate, litigation, and land schemes to be the most widespread apart from the other supplementary tactics such as the creation and presentation of false evidence in civil litigation. At least three causes can be identified, first is the general uncertainty of property rights resulting from the privatization of state assets, second cause is poor corporate governance and final cause of raiding is the fact that the legal system is simply not yet equipped to deal with this novel form of crime. The court structure, the inadequacy of criminal law, the flaws in criminal investigation, the problems of good faith purchaser and the verification of corporate documents are also among the loopholes that can be identified. In order to address this problem, a new bankruptcy law must be imposed with more stringent screening and ethical requirements for trustees, expanding the time for judges to consider and take decisions, and also expand debtors' rights to contest creditors' petitions. The corrupt acquisition of control over the target company usually by falsifying internal corporate documents and/or corruptly obtaining control over a significant portion of the voting stock or the board of directors of the target company is common in nature. The raider may create a false power of attorney or other document authorizing him or a co-conspirator to enter into transactions on behalf of the target company and then transfer the target's assets to himself or affiliated companies or the raider bribes officials at state registration agencies to alter the target company's registration documents to give him and/or his confederates faux control over the target company. He then uses this control to drain off the target's assets. Another important tactic that may be used by raider is the creation and presentation of false evidence in civil litigation. For example, in answering claims by victims, raiders typically offer false evidence, such as fabricated contracts and corporate resolutions, to "prove" the alleged legitimacy of their acquisitions. There are certain measures that businesses can take to protect themselves. These measures include retaining qualified legal counsel to draft and review all incorporation documents and contracts, retaining corporate investigation firms to investigate partners and major customers, and, above always complying with all relevant laws and regulations.
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The term takeover' is nowhere defined in the Companies Act 1956 (Act) or in Securities and Exchange Board of India Act, 1992 (SEBI Act), or in SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (Takeover Code). In the absence of a legal definition, the term takeover has to be understood from its commercial usage. In commercial parlance, the term takeover denotes the act of a person or group of persons (acquirer) acquiring shares or acquiring voting rights or both of a company (target company), from its shareholders, either through private negotiations with majority shareholders, or by a public offer in the open market with an intention to gain control over its management. A takeover is considered hostile' when the management of the target company resists the attempted takeover. The basic principle is that when acquisition becomes a takeover, the Takeover Code becomes applicable besides other provisions of the Act. In other words, in case of a takeover, compliance of both the Takeover Code as well as that of the Act is necessary, while in case of acquisition, compliance of only the Act is required. Further, if an acquisition results in a combination', then the provisions of the Competition Act 2002 also become applicable, and the approval of the Competition Commission of India is required. If the acquisition results in either inflow or outflow of funds, to or from India, then the provisions of the Foreign Exchange Management Act 1999 would become applicable and in such a case, the permission from either the Reserve Bank of India or the Central Government may be required. The objective behind the Takeover Code is to bring transparency in takeover and acquisition transactions in public listed companies and to ensure that if minority shareholders are not given a raw deal through price fixation. The Takeover Code lays down the mandatory and compulsory disclosure of an acquisition if the acquirer intends to do. The procedure in case an investor wants to takeover has been clearly laid down in the Companies Act, 1956, the Takeover Code etc,. These regulatory mechanisms also lays down the offences, penalties in case of any violation, obligations and restrictions upon the merchant bankers, acquirers, the company itself etc,. Acquisition for the purpose of combination is not only the acquisition of shares or voting rights or control of management, but also acquisition of or control of assets of the target company. Thus, for the purposes of Competition Act, 2002, acquisition of shares, voting rights, assets and control of management have to be considered. In Any combination that would result in appreciable adverse effect on competition, within them relevant market in India, would be declared null and void and such an effect is to be enquired by the CCI for which the powers and the procedure is laid down under the Competition Act, 2002. However, the era of the corporate raider appears to be largely over. In the later 1980s the famous raiders suffered from a number of bad purchases that lost money (for their backers, primarily) and the credit lines dried up. In addition, corporations became more adept at fighting hostile takeovers through mechanisms such as the poison pill. Finally the overall price of the stock market increased, which reduced the number of situations in which a company's share price was low with respect to the assets that it controlled. Defence techniques Preventive measures

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Preventive measures against hostile takeovers are much more effective than reactive measures implemented once takeover attempts have already been launched. The first step in a companys defence, therefore, is for management and controlling shareholders to begin their preparations for a possible fight long before the battle is joined. There are several principal weapons in the hands of target management to prevent takeovers, some of which are described below. Control over the register The raider needs to know who the shareholders of the target are in order to approach them with the offer to sell their shares. With joint stock companies this information is contained in the share register. In particular, the share register provides for the possibility to identify the owners of the shares, quantity, nominal value and type of shares held by shareholders. So it is very important to ensure that non-authorized persons do not have access to the share register of the company by taking the following steps: Careful consideration is needed when choosing the registrar; the preference should be given to a reputable registrar; Check the track record of the share registrar in regards to its involvement in hostile takeovers in the past; Check who controls the registrar company. In case of transfer of shares to a nominee holder (custodian or depository) information on the beneficiary owners of shares is not stated in the share register. Instead, the share register contains information on the nominee holders. This makes it much more difficult for the raider to identify who is the real owner of the shares. Control over debts Creditor indebtedness of the company may be used by a raider as the principal or auxiliary tool in the process of hostile takeover. In particular, the raider may employ so-called contract bankruptcy in order to acquire the assets of the target. In connection with this the following cautionary measures should be taken: Monitor the creditors of company carefully; Prevent overdue debts; If there is indirect evidence that a bankruptcy procedure is about to be launched, the company should do its best to pay all outstanding debts; Accumulate all the debts and risks relating to commercial activity of the company on a special purpose vehicle that does not hold any substantial assets. Cross shareholding Several subsidiaries of a company (at least three) have to be established, where the parent company owns 100% of share capital in each subsidiary. The parent transfers to subsidiaries the most valuable assets as a contribution to the share capital. Then the subsidiaries issue more shares. The amount of these should be more than four times the initial share capital. Subsidiaries then distribute the shares among themselves. The result of such an operation is that the parent owns less that 25% of the share capital of each subsidiary. In other words the parent company does not even have a blocking shareholding. When implementing this. Golden parachute

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This measure discourages an unwanted takeover by offering lucrative benefits to the current top executives, who may lose their job if their company is taken over by another firm. The triggering events that enable the golden parachute clause are change of control over the company and subsequent dismissal of the executive by a raider provided that this dismissal is outside the executives control (for instance, reduction in workforce2 or dismissal of the head of the board of directors due to the decision of the general meeting of shareholders provided such additional ground for dismissal is stated in the labour contract with the head of the board3). Benefits written into the executives contracts may include items such as stock options, bonuses, hefty severance pay and so on. Golden parachutes can be prohibitively expensive for the acquiring firm and, therefore, may make undesirable suitors think twice before acquiring a company if they do not want to retain the targets management nor dismiss them at a high price. The golden parachute defence is widely used by American companies. The presence of golden parachute plans at Fortune 1000 companies increased from 35% in 1987 to 81% in 2001, according to a survey by Executive Compensation Advisory Services. Notable examples include ex- Mattel CEO Jill Barads USD 50 million departure payment, and Citigroup Inc. John Reeds USD 30 million in severances and USD 5 million per year for life. Change of control clauses (Shark Repellents) The company may include in loan agreements or some other agreements conditional covenants that in the event of the company passing under the control of a third party, the other party to the agreement has the right to accelerate the debt or terminate the contract. The result of such agreements is that a potential raider may not be sure whether it will be able to benefit from important advantages enjoyed by the target. Although one of the effects of change of control clauses is to discourage raiders, their purpose is legitimate: to protect creditors from being placed in a worse position than they visualised.

Q.2 Discuss the factors in post-merger integration process. Answer: Some important factors that can contribute to success or failure in mergers and acquisitions are: Due Diligence: Lack of due diligence has caused many merger failures. It involves comprehensive analysis of firm characteristics such as financial condition, management capabilities, physical assets and intangible assets. Financing: Manageable debt levels should be ensured. Complementary Resources: Occurs when the primary resources of the acquiring and target firms are somewhat different, yet simultaneously supportive of one another. This tends to create economic value to a greater value that exists when the merging firms have identical or unrelated resources.

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Friendly/Hostile Acquisitions: Friendly acquisitions tend to create greater economic value. A hostile acquisition can reduce the transfer of information during due diligence and merger integration, and increase turnover of key executives in the firm being acquired. Synergy Creation: Four foundations to creation of synergy are strategic fit, organizational fit, managerial actions and value creation. Organizational Learning: Many people should participate in the acquisition process to ensure knowledge about acquisitions is being spread throughout the firm, and isnt lost if one of the key people typically involved leaves. The learning process should be managed, with steps taken to study and learn from acquisitions, with the information gained recorded. Focus on Core Business: Cultural and management differences are more greatly magnified the less firms have in common, therefore constraining the sharing of resources and capabilities. Result is that positive benefits from financial synergy are not enough to offset the negative effects of diversification.; Emphasis on Innovation: Innovation is critical to organizational competitiveness. Companies that innovate enjoy the first-mover advantages of acquiring a deep knowledge of new markets and developing strong relationships with key stakeholders in those markets. Ethical Concerns/Opportunism: Risk in mergers and acquisitions are that the information received may be incorrect, misleading or deceptive. Steps should be taken to ensure that the information is accurate and hasnt been manipulated by management with the aim to making performance appear higher than it is.

Q.3 What is the basis for valuation of a target company? Answer: Overview of Acquisition Valuation Methods There are a number of acquisition valuation methods. While the most common is discounted cash flow, it is best to evaluate a number of alternative methods, and compare their results to see if several approaches arrive at approximately the same general valuation. This gives the buyer solid grounds for making its offer. Using a variety of methods is especially important for valuing newer target companies with minimal historical results, and especially for those growing quickly all of their cash is being used for growth, so cash flow is an inadequate basis for valuation. Valuation Based on Stock Market Price If the target company is publicly held, then the buyer can simply base its valuation on the current market price per share, multiplied by the number of shares outstanding. The actual price paid is usually higher, since the buyer must also account for the control premium. The current trading price of a companys stock is not a good valuation tool if the stock is thinly traded. In this case, a small number of trades can alter the market price to a substantial extent, so that the buyers
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estimate is far off from the value it would normally assign to the target. Most target companies do not issue publicly traded stock, so other methods must be used to derive their valuation. When a private company wants to be valued using a market price, it can adopt the unusual ploy of filing for an initial public offering while also being courted by the buyer. By doing so, the buyer is forced to make an offer that is near the market valuation at which the target expects its stock to be traded. If the buyer declines to bid that high, then the target still has the option of going public and realizing value by selling shares to the general public. However, given the expensive control measures mandated by the Sarbanes-Oxley Act and the stock lockup periods required for many new public companies, a targets shareholders are usually more than willing to accept a buyout offer if the price is reasonably close to the targets expected market value. Valuation Based on a Multiple Another option is to use a revenue multiple or EBITDA multiple. It is quite easy to look up the market capitalizations and financial information for thousands of publicly held companies. The buyer then converts this information into a multiples table, which itemizes a selection of valuations within the consulting industry. The table should be restricted to comparable companies in the same industry as that of the seller, and of roughly the same market capitalization. If some of the information for other companies is unusually high or low, then eliminate these outlying values in order to obtain a median value for the companys size range. Also, it is better to use a multiday average of market prices, since these figures are subject to significant daily fluctuation. The buyer can then use this table to derive an approximation of the price to be paid for a target company. For example, if a target has sales of $100 million, and the market capitalization for several public companies in the same revenue range is 1.4 times revenue, then the buyer could value the target at $140 million. This method is most useful for a turn-around situation or a fast growth company, where there are few profits (if any). However, the revenue multiple method only pays attention to the first line of the income statement and completely ignores profitability. To avoid the risk of paying too much based on a revenue multiple, it is also possible to compile an EBITDA (i.e., earnings before interest, taxes, depreciation, and amortization) multiple for the same group of comparable public companies, and use that information to value the target. Better yet, use both the revenue multiple and the EBITDA multiple in concert. If the revenue multiple reveals a high valuation and the EBITDA multiple a low one, then it is entirely possible that the target is essentially buying revenues with low-margin products or services, or extending credit to financially weak customers. Conversely, if the revenue multiple yields a lower valuation than the EBITDA multiple, this is more indicative of a late-stage company that is essentially a cash cow, or one where management is cutting costs to increase profits, but possibly at the expense of harming revenue growth. If the comparable company provides one-year projections, then the revenue multiple can be renamed a trailing multiple (for historical 12-month revenue), and the forecast can be used as the basis for a forward multiple (for projected 12-month revenue). The forward multiple gives a better estimate of value, because it incorporates expectations about the future. The forward multiple should only be used if the forecast comes from guidance that is issued by a public
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company. The company knows that its stock price will drop if it does not achieve its forecast, so the forecast is unlikely to be aggressive. Revenue multiples are the best technique for valuing high-growth companies, since these entities are usually pouring resources into their growth, and have minimal profits to report. Such companies clearly have a great deal of value, but it is not revealed through their profitability numbers. However, multiples can be misleading. When acquisitions occur within an industry, the best financial performers with the fewest underlying problems are the choicest acquisition targets, and therefore will be acquired first. When other companies in the same area later put themselves up for sale, they will use the earlier multiples to justify similarly high prices. However, because they may have lower market shares, higher cost structures, older products, and so on, the multiples may not be valid. Thus, it is useful to know some of the underlying characteristics of the companies that were previously sold, to see if the comparable multiple should be applied to the current target company. Valuation Based on Enterprise Value Another possibility is to replace the market capitalization figure in the table with enterprise value. The enterprise value is a companys market capitalization, plus its total debt outstanding, minus any cash on hand. In essence, it is a companys theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, while pocketing any remaining cash. Valuation Based on Comparable Transactions Another way to value an acquisition is to use a database of comparable transactions to determine what was paid for other recent acquisitions. Investment bankers have access to this information through a variety of private databases, while a great deal of information can be collected on-line through public filings or press releases. Valuation Based on Real Estate Values The buyer can also derive a valuation based on a targets underlying real estate values. This method only works in those isolated cases where the target has a substantial real estate portfolio. For example, in the retailing industry, where some chains own the property on which their stores are situated, the value of the real estate is greater than the cash flow generated by the stores themselves. In cases where the business is financially troubled, it is entirely possible that the purchase price is based entirely on the underlying real estate, with the operations of the business itself being valued at essentially zero. The buyer then uses the value of the real estate as the primary reason for completing the deal. In some situations, the prospective buyer has no real estate experience, and so is more likely to heavily discount the potential value of any real estate when making an offer. If the seller wishes to increase its price, it could consider selling the real estate prior to the sale transaction. By doing so, it converts a potential real estate sale price (which might otherwise be discounted by the buyer) into an achieved sale with cash in the bank, and may also record a one-time gain on its books based on the asset sale, which may have a positive impact on its sale price.

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Valuation Based on Product Development Costs If a target has products that the buyer could develop in-house, then an alternative valuation method is to compare the cost of in-house development to the cost of acquiring the completed product through the target. This type of valuation is especially important if the market is expanding rapidly right now, and the buyer will otherwise forego sales if it takes the time to pursue an in-house development path. In this case, the proper valuation technique is to combine the cost of an in-house development effort with the present value of profits foregone by waiting to complete the in-house project. Interestingly, this is the only valuation technique where most of the source material comes from the buyers financial statements, rather than those of the seller. Valuation Based on Liquidation Value The most conservative valuation method of all is the liquidation value method. This is an analysis of what the selling entity would be worth if all of its assets were to be sold off. This method assumes that the ongoing value of the company as a business entity is eliminated, leaving the individual auction prices at which its fixed assets, properties, and other assets can be sold off, less any outstanding liabilities. It is useful for the buyer to at least estimate this number, so that it can determine its downside risk in case it completes the acquisition, but the acquired business then fails utterly. Valuation Based on Replacement Cost The replacement value method yields a somewhat higher valuation than the liquidation value method. Under this approach, the buyer calculates what it would cost to duplicate the target company. The analysis addresses the replacement of the sellers key infrastructure. This can yield surprising results if the seller owns infrastructure that originally required lengthy regulatory approval. For example, if the seller owns a chain of mountain huts that are located on government property, it is essentially impossible to replace them at all, or only at vast expense. An additional factor in this analysis is the time required to replace the target. If the time period for replacement is considerable, the buyer may be forced to pay a premium in order to gain quick access to a key market. While all of the above methods can be used for valuation, they usually supplement the primary method, which is the discounted cash flow method.

Q.4 What are the legal compliance issues a company has to adhere to in case of a merger. Explain through an example. Answer: There are only seven sections from section 390 to 396 in the Companies act 1956 which are related to the matters pertaining to Mergers and Acquisitions and have been given in Chapter V under the heading Arbitration, Compromises, Arrangements and Reconstruction. The Act lays down the legal procedures for mergers or acquisitions: Permission for merger: Two or more companies can amalgamate only when the amalgamation is permitted under their memorandum of association. Also, the acquiring company should have the permission in its object clause to carry on the business of the acquired company. In the absence of these provisions in the memorandum of association,
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it is necessary to seek the permission of the shareholders, board of directors and the Company Law Board before affecting the merger. Information to the stock exchange: The acquiring and the acquired companies should inform the stock exchanges about the merger. Approval of board of directors: The board of directors of the individual companies should approve the draft proposal for amalgamation and authorize the managements of the companies to further pursue the proposal. Application in the high court: An application for approving the draft amalgamation proposal duly approved by the board of directors of the individual companies should be made to the High Court. Shareholders and creators meetings: The individual companies should hold separate meetings of their shareholders and creditors for approving the amalgamation scheme. At least, 75 percent of shareholders and creditors in separate meetings, voting in person or by proxy, must accord their approval to the scheme. Sanction by the high court: After the approval of the shareholders and creditors, on the petitions of the companies, the High Court will pass an order, sanctioning the amalgamation scheme after it is satisfied that the scheme is fair and reasonable. The date of the courts hearing will be published in two newspapers, and also, the regional director of the Company Law Board will be intimated. Filing of the court order: After the Court order, its certified true copies will be filed with the Registrar of Companies. Transfer of assets and liabilities: The assets and liabilities of the acquired company will be transferred to the acquiring company in accordance with the approved scheme, with effect from the specified date. Payment by cash or securities: As per the proposal, the acquiring company will exchange shares and debentures and/or cash for the shares and debentures of the acquired company. These securities will be listed on the stock exchange.

Q.5 Choose any firm of your choice and identify suitable acquisition opportunity and give reasons for the same. Answer: Identifying takeover opportunities The basic purpose of valuation of Target Company is to locate the possibilities of takeover. Valuation technique discussed above serves the purpose of identification of target companies for takeover as well as serves the basic purpose of fixing exchange ratio in case the target company is finally selected for acquisition. Some financial experts suggest selection criteria based on following two approaches. Present value analysis: The present value analysis is more or less the same as valuation on net maintaining earning basis for listed companies and the technique is the same as used for dividend analysis. In other words, the earnings or the target firm are projected and discounted at the acquirers cost of capital to obtain a theoretical market price on the shares of the target company.

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This is then compared with the actual market price to determine the net present value on investments. For calculating theoretical price the following example will serve the purpose: Given the following data I=k=Acquirer Cos cost of capital 10% D0 = p0 For target cos payout ratio at Rs. 1 per share. MPS for Target Cos market price per share Rs. 50 -For Target Cos merger @ 100% basis g for Target Cos earning and dividend expected to grow at 8% p.a. using above data and the formula for the constant annual growth rate of dividend d0 (1+g) / (i-g) as discussed earlier in dividend approach, then target companys theoretical price is as under: P = P0 (1+g) / (k-g) = 1(1.08) / .10 .08 = 1.08 / .02 = 54 The theoretical price exceeds the Market Price i.e. 54 50 = 4. here, NPV is 4 per share. The result requires reconsideration. The above approach does not consider the risk posture of acquisition i.e. the portfolio effect. The capital assets pricing model considers these aspects as discussed below. Capital assets pricing: The above approach provides a superior theoretical framework and is helpful in identifying a merger partner, the target company. The basic logic behind the model is that if expected rate of return exceeds the required rate of return, then the acquirer company has green signal for acquiring the target company. The required rate of return is calculated by solving the following equation: E (Rj) = Rf+ [E (Rm) Rf] (Bj) Where, E (Rj) = Required return E (Rj) = Expected return E (Rm) = Expected return for market index Rf = Risk free return Bj = Beta (normally determines past performance) j = Potential merger partner (target company)

Q.6 Take a cross border acquisition by an Indian company and critically evaluate. Answer: In a study conducted in 2000 by Lehman Brothers, it was found that, on average, large M&A deals cause the domestic currency of the target corporation to appreciate by 1% relative to the acquirer's. For every $1-billion deal, the currency of the target corporation increased in value by 0.5%. More specifically, the report found that in the period immediately after the deal is announced, there is generally a strong upward movement in the target corporation's domestic currency (relative to the acquirer's currency). Fifty days after the announcement, the target currency is then, on average, 1% stronger.

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The rise of globalization has exponentially increased the market for cross border M&A. In 1996 alone there were over 2000 cross border transactions worth a total of approximately $256 billion. This rapid increase has taken many M&A firms by surprise because the majority of them never had to consider acquiring the capabilities or skills required to effectively handle this kind of transaction. In the past, the market's lack of significance and a more strictly national mindset prevented the vast majority of small and mid-sized companies from considering cross border intermediation as an option which left M&A firms inexperienced in this field. This same reason also prevented the development of any extensive academic works on the subject. Due to the complicated nature of cross border M&A, the vast majority of cross border actions have unsuccessful results. Cross border intermediation has many more levels of complexity to it then regular intermediation seeing as corporate governance, the power of the average employee, company regulations, political factors customer expectations, and countries' culture are all crucial factors that could spoil the transaction.[3][4] Because of such complications, many business brokers are finding the International Corporate Finance Group and organizations like it to be a necessity in M&A today.
Table 1.1 Largest M&A deals worldwide since 2000:

Rank

Year

Acquirer Merger: America Online Inc. (AOL) Glaxo Wellcome Plc. Royal Dutch Petroleum Co. AT&T Inc. Comcast Corporation Sanofi-Synthelabo SA Spin-off : Nortel Networks Corporation Pfizer Inc. Merger : JP Morgan Chase & Co. Pending: E.on AG Total

Target

Transaction Value (in Mil. USD) 164,747 75,961 74,559 72,671 72,041 60,243 59,974

1 2 3 4 5 6 7 8 9 10

2000 2000 2004 2006 2001 2004 2000 2002 2004 2006

Time Warner SmithKline Beecham Plc. Shell Transport & Trading Co BellSouth Corporation AT&T Broadband & Internet Svcs Aventis SA

21.83 10.06 9.87 9.62 9.54 7.98 7.95 7.89 7.79 7.74 100

Pharmacia Corporation Bank One Corporation Endesa SA

59,515 58,761 56,266 754,738

Source: Institute of Mergers, Acquisitions and Alliances Research, Thomson Financial

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Table: 1.1 and fig.1.1 show the ten largest M&A deals worldwide since 2000. Table and figure reflects that the largest M & A deal during last 6 year was between American Online Inc and. Time Warner of worth $ 164,747 million during 2000, which account 21.83% of total transaction value of top ten worldwide merger and acquisition deals. While second largest deal was between Glaxo Wellcome Plc. & SmithKline Beecham Plc. Of US $ 75,961 million which was also occurred during 2000, which was 10.06 % of total transaction value of top ten worldwide M & a deals & third largest deal was between Royal Dutch Petroleum Co. Shell Transport & Trading Co of worth US $ 74,559 million, it is 9.87 % of total transaction value of top ten worldwide M & a deals. Cross-border Merger and acquisition: India Until up to a couple of years back, the news that Indian companies having acquired AmericanEuropean entities was very rare. However, this scenario has taken a sudden U turn. Nowadays, news of Indian Companies acquiring a foreign businesses are more common than other way round. Buoyant Indian Economy, extra cash with Indian corporates, Government policies and newly found dynamism in Indian businessmen have all contributed to this new acquisition trend. Indian companies are now aggressively looking at North American and European markets to spread their wings and become the global players. The Indian IT and ITES companies already have a strong presence in foreign markets, however, other sectors are also now growing rapidly. The increasing engagement of the Indian companies in the world markets, and particularly in the US, is not only an indication of the maturity reached by Indian Industry but also the extent of their participation in the overall globalization process. Acquirer Tata Steel Hindalco Target Company Corus Group plc Novelis Country targeted UK Canada Deal value ($ ml) 12,000 5,982 Industry Steel Steel
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Daewoo Korea 729 Electronics Electronics Corp. Dr. Reddy's Labs Betapharm Germany 597 Pharmaceutical Suzlon Energy Hansen Group Belgium 565 Energy Kenya Petroleum HPCL Kenya 500 Oil and Gas Refinery Ltd. Ranbaxy Labs Terapia SA Romania 324 Pharmaceutical Tata Steel Natsteel Singapore 293 Steel Videocon Thomson SA France 290 Electronics VSNL Teleglobe Canada 239 Telecom If you calculate top 10 deals itself account for nearly US $ 21,500 million. This is more than double the amount involved in US companies' acquisition of Indian counterparts. Graphical representation of Indian outbound deals since 2000. Videocon

Indian outbound deals, which were valued at US$ 0.7 billion in 2000-01, increased to US$ 4.3 billion in 2005, and further crossed US$ 15 billion-mark in 2006. In fact, 2006 will be remembered in India's corporate history as a year when Indian companies covered a lot of new ground. They went shopping across the globe and acquired a number of strategically significant companies. This comprised 60 per cent of the total mergers and acquisitions (M&A) activity in India in 2006. And almost 99 per cent of acquisitions were made with cash payments. Table 1.3: Cross-border Merger and acquisition: India (US $ Million) Year Sales 2000 1219 2001 1037 2002 1698 2003 949 2004 1760 2005 4210 Total 10873

Purchases 910 2195 270 1362 863 2649 8249

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Source: UNCTAD world investment report 2006

Table 1.3 & figure 1.3 exhibit Cross border merger and acquisition in India for the period 2000 to 2005. Table shows the cross border sales deals during 2000 were 1219 US $ million while purchase deal were 910 US $ million. But during 2005, these have been increased to 4210 US $ million and 2649 US $ million. While overall sales are 10,873 US $ million and purchase deals were 8249 US $ million during last five years. So table clearly depicts that our cross border merger and acquisition sales deals are more then purchase deals.

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