M&A process

Hostile Takeover & Takeover Defenses

Valuation of Intangibles

By Sudha Agarwal
Chartered Accountant
 Contents

 Mergers and Acquisitions Process

 Legal Procedure
 Tax Aspects
 Methods of Payment
 Accounting for M&A
 Major challenges to success of M&A
 Major reasons why M&A fail
 Hostile takeovers and Defensive tactics
 Valuation of Intangibles
 Valuation of Brand
 Valuation of Goodwill
 Human Resource Valuation
 Mergers and Acquisitions Process

 A merger is a fairly complex transaction, involving

a web of legal, taxation and accounting angles
 If the entities – bidder and the target companies –
are located in different countries, it can become
more complex and tedious.
 Deal structuring is a detailed process and
involves the choice of accounting method,
taxability, methods of payment, premiums,
contingent payouts, etc. in designing the terms of
a transaction.
 Legal Procedure

1. Examination of Object Clauses

2. Intimation to Stock Exchanges
3. Approval of the draft amalgamation proposal by
the respective boards of the companies
4. Application to the National Company Law Tribunal
(NCLT)
5. Dispatch of notice to shareholders and creditors
6. Holding of meetings of shareholders and creditors
7. Petition to the NCLT for confirmation and passing
of NCLT orders
8. Filing the order with the Registrar of companies
9. Transfer of assets and liabilities
10.Issue of shares and debentures
 Tax Aspects

 affect the planning and structuring of corporate

mergers.
 transactions are structured to maximize tax
benefits while complying with various tax laws
 Though tax effects are not the dominant influence
in merger and acquisition decisions, their impact
can be substantial
 Tax benefits and concessions are available to the
merged entity, subject to certain conditions.
 These need to be ascertained and complied with
to enable the company, for instance, to carry
forward losses and unabsorbed depreciation.
 Methods of Payment

Cash:
 This method is generally considered suitable for relatively small
acquisitions.
 It has two advantages: (i) the buyer retains total control as the
shareholders in the selling company are completely bought out, and
(ii) the value of the bid is known and the process is simple.

Share exchange:
 The method of payment in large transactions is predominantly stock
for stock
 The advantage of this method is that the acquirer does not part with
cash and does not increase the financial risk by raising new debt
 The disadvantage is that the acquirer’s shareholders will have to share
future prosperity with those of the acquired company
 Accounting for M&A

 Pooling of interests accounting – Balance sheets

of two firms are basically added together
 Purchase Accounting
– Assets of acquired firm are written up to fair market
value
– Goodwill is created – difference between purchase
price and estimated fair market value of net assets
– Goodwill must be depreciated going forward
– Equity of acquired firm is bought out
 Major challenges to success of M&A

 Due diligence – it involves

1. Examination of all aspects of partners
2. Legal: including pension, product and
environmental liabilities
3. Relevance of accounting records
4. The maintenance and quality of assets and
facilities
5. The possibility of maintaining cost controls
6. Potential for product improvements
 Major challenges to success of M&A

Cultural factors –
 Corporate culture is defined by an organization’s values,
traditions, norms, beliefs and behavior patterns
 The organization must move towards cultural
congruence, and also learn to manage diversity.

Implementation difficulties -
 Speed is everything in the integration process.
 Private-equity investors typically develop 120-day plans.
These are detailed plans that explain how management
teams are going to be integrated, what the operating
metrics are going to be, how management will be
measured, and what changes need to be made.
 Major reasons why M&A fail

1. Lack of fit due to differences in management

styles or corporate structure
2. Lack of commercial fit
3. Paying too much
4. Cheap purchases turning out to be costly in
terms of resources required to turnaround the
acquired company
5. Lack of commonality of goals
6. Failure to integrate effectively
7. Ineffective change management
 Hostile Takeovers

 A takeover is considered "hostile" if the target company's

board rejects the offer, but the bidder continues to
pursue it
 or the bidder makes the offer without informing the target
company's board beforehand

 Killer bees are firms or individuals that are employed by

a target company to fend off a takeover bid; these
include investment bankers (primary), accountants,
attorneys, tax specialists, etc
 They aid by utilizing various anti-takeover strategies,
thereby making the target company economically
unattractive and acquisition more costly.
 Types of Hostile Takeover
 Tender offer: acquiring company makes a public
offer at a fixed price above the current market price

 Creeping Tender offer: purchasing enough stock on

the open market, known as a creeping tender offer, to
effect a change in management

 Proxy Fight: tries to persuade enough shareholders,

usually a simple majority, to replace the management
with a new one which will approve the takeover
 Takeover Defenses

Takeover defenses, also referred to as anti-

takeover defenses, comprise of the following
strategies:
1. Operating performance - Growth in
operations, Efficiency of operations, Efficiency of
capital management including working capital
management, Meet or exceed expectations
2. Financial techniques - Liquidate marketable
securities, Issue debt, Structure debt so that if an
acquisition occurs, the debt must be paid off,
Repurchase stock, Increase dividends, Pay a
one-time, extraordinary dividend
 Takeover Defenses

3. Restructuring and financial engineering -

Ownership reorganization, Employee stock
ownership plans (ESOP’s), Financial
restructuring, Reorganize in an anti-takeover
friendly state
4. Anti-takeover charter amendments - Board
provisions, Fair price provisions, Shark Repellent
- Amendments to a company charter made to
forestall takeover attempts, Supermajority votes,
Super voting stock (dual recapitalization),
Eliminate cumulative voting, Anti-green mail
amendment (restricts BOD to buy back shares),
Limit shareholder action
 Takeover Defenses
5. Other board or management methods –

1. Poison Pill - Measure taken by a target firm to avoid

acquisition; for example, the right for existing
shareholders to buy additional shares at an attractive
price if a bidder acquires a large holding
With a poison pill, the target company attempts to make
its stock less attractive to the acquirer

a. Flip-over plan - allows stockholders to buy the

acquirer's shares at a discounted price after the merger

b. Flip-in plan - allows existing shareholders (except the

acquirer) to buy more shares at a discount
 Takeover Defenses
c. Dead-hand provisions - stipulating that only persons
who were members of the board of directors at the time
the antitakeover measure was put into place have the
power to rescind the antitakeover measure.

d. Back-end plans – the shareholder receive a right

dividend which give share holder ability to exchange this
right along with the share of stock for cash or senior
securities that are equal in value to a specific “back-end”
price stipulated by the issuer's board of directors

e. Poison puts - this bond allows investors to cash in the

security before it matures, if the target company is
engaged in a hostile takeover attempt

2. Authorization of preferred equity privately placed with

favourable vote
 Takeover Defenses
3. Parachutes:
a. Golden Parachute - Special lucrative
compensation agreements that the company
provide to Top management
b. Silver Parachute - if it is given to most of the
firms employees
c. Tin Parachute - Tin parachutes are basically
severance payments for rank-and-file employees
that kick in if a hostile takeover costs employees
their jobs
4. Negotiate contracts for labour, rent, etc. that
increase with management change.
 Takeover Defenses
6. Post-acquisition bid techniques -
1. Just say no
2. Greenmail - refers to the payment of a substantial premium for a
significant shareholder’s stock in return for the stockholder’s agreement that
he or she will not initiate a bid for control of the company
3. Standstill agreements - A contract that stalls or stops the process of a
hostile takeover. The target firm either offers to repurchase the shares held
by the hostile bidder, usually at a large premium, or asks the bidder to limit
its holdings
4. Pac-Man defense - It occurs when the Target makes an offer to buy the
Hostile company in response to Hostile bid for the Target
5. Implement other acquisition plans
6. White Knight or white squire - Friendly potential acquirer sought by a
target company threatened by an unwelcome suitor. A White Squire is a firm
that consents to purchase a large block of the target company’s stock
7. Divest ‘crown jewels’ - It is a strategy in which the target company sells off
its most attractive assets to a friendly third party or spin off the valuable
assets in a separate entity
8. Litigation:
a. Anti-trust effect of acquisition
b. Material information missing from SEC filing
9. Create anti-trust incompatibility
10. Trigger the application of state anti-takeover laws
 Intangibles

 Intangible assets are assets with the following

characteristics:
a. with future economic benefits,
b. no physical substance,
c. with high degree of uncertainty concerning the
future benefit
 Intangible assets include Brands, expenditure on
research and development (R&D), intellectual
capital, technology, patents, copyrights, people,
franchises, goodwill, organization costs, trade
names, trademarks, etc
 Cost of Intangibles

 Intangibles are recorded at cost and are also

reported at cost at the end of an accounting
period but are subject to amortization (a process
of cost allocation).
 Cost of Intangibles includes acquisition costs
plus any other expenditure necessary to make
the intangibles ready for the intended uses (i.e.,
purchase price, legal fees, etc.).
 Valuation of Intangibles

 The four methodologies for valuation of intangibles are:

discounted cash flows, relief-from-royalty, comparable
transactions and avoided-cost.
 The first two methods are the income approach, and the
other two are the market and asset-replacement
approach, respectively.
 The income approach – commonly used to value
intangible assets – calls for methods that include direct
capitalization, profit split, excess earnings and loss of
income.
 An asset-replacement cost approach also should
consider the reproduction and replacement cost as well
as the cost avoidance method.
 Valuation of Intangibles

Discounted cash flows

 used to value intangible assets such as technology,
software, customer relationships, strategic agreements,
franchises and distribution channels
 value of an asset reflects the present value of the
projected earnings that will be generated by the asset
after taking into account the revenues and expenses of
the asset, the relative risk of the asset, the contribution of
other assets, and a discount rate that reflects the time
value of invested capital.

Relief-from-royalty –
 used to value trade names and trademarks.
 value of an asset is equal to all future royalties that would
have to be paid for the right to use the asset if it were not
acquired
 Valuation of Intangibles
Comparable Transactions -
 to value marketing-related intangible assets.
 The value of an asset is based on actual prices paid for assets with
functional or technical attributes similar to the subject asset.
 Using this data, relevant market multiples or ratios of the total
purchase price paid are developed and applied
to the subject asset

Avoided cost –
 useful method to value technology
 It is based on historical data, and does not rely on the subjective
assumptions employed under the other methodologies
 the value of an asset is based on calculating the costs avoided by
the acquiring company when obtaining a pre-existing, fully functional
asset rather than incurring the costs to build or assemble the asset
 The savings realized may include actual and opportunity costs
associated with avoided productivity losses.
 Valuation of Brand
 The brand is a special intangible that in many businesses is the most
important asset. This is because of the economic impact that brands
have.
 There are two broad approaches to Brand Valuation:
1) Cost-based approach: Defines the value of a brand as the
aggregation of all historic costs incurred or replacement costs
required in bringing the brand to its current state.
The unwritten off amount of the branding related expenses is
the Brand Value
2) Comparable to generic company:
a. Arrive at a value for a brand on the basis of something
comparable
b. Difficult - as by definition brands should be differentiated
c. The value creation of brands in the same category can be very
different, even if most other aspects such as target groups,
advertising spend, price promotions and distribution
channel are similar or identical
 Valuation of Brand
e. Some models add behavioral measures such as market share
and relative price
f. These approaches do not differentiate between the effects of other
influential factors such as R&D and design and the brand

i) Operating margin approach -

 Find value of Branded company by applying operating margin% of
branded company on Revenue of branded company and finding Profit
after taxes
 Apply growth % for explicit number of years (n) and stable growth %
for determining Terminal value (TV).
 Find present value of PAT for n years and present value of TV.
 This is the first value of the branded company.
 Then find the value of the branded company by applying the operating
margin% of the generic company on Revenue of branded company
and finding Profit after taxes. Continue the above process and find the
2nd Value of the branded company.
 The difference between both the values is the brand value
 Valuation of Brand
ii) Return on Capital (ROC) approach -
 Find value of Branded company by applying ROC% of branded
company on Capital employed of branded company and finding Profit
after taxes
 Apply growth % for explicit number of years (n) and stable growth %
for determining Terminal value (TV).
 Find present value of PAT for n years and present value of TV.
 This is the first value of the branded company.
 Then find the value of the branded company by applying the ROC% of
the generic company on Capital employed of branded company and
finding Profit after taxes. Continue the above process and find the 2nd
Value of the branded company.
 The difference between both the values is the brand value
 Valuation of Brand
iii) Excess Return approach (ROC-k)-
 Find value of Branded company by applying excess return % of
branded company on Capital employed of branded company and
finding Profit after taxes
 Apply growth % for explicit number of years (n) and stable growth %
for determining Terminal value (TV).
 Find present value of PAT for n years and present value of TV.
 This is the first value of the branded company.
 Then find the value of the branded company by applying the excess
return% of the generic company on Capital employed of branded
company and finding Profit after taxes. Continue the above process
and find the 2nd Value of the branded company.
 The difference between both the values is the brand value
 Brand valuation by Infosys Technologies

The methodology followed for valuing the brand is given

below:
 Determine brand profits by eliminating the non-brand
profits from the total profits
 Restate the historical profits at present-day values
 Provide for the remuneration of capital to be used for
purposes other than promotion of the brand
 Adjust for taxes
 Determine the brand-strength or brand-earnings multiple
 Brand-strength multiple is a function of a multitude of
factors such as leadership, stability, market,
internationality, trend, support and protection
 Infosys has internally evaluated these factors on a scale
of 1 to 100, based on the information available within
 Brand valuation by Infosys Technologies

2007 2006 2005

Profit before interest and tax 3877 2654 2048
Less : Non Brand income 335 125 1125
Adjusted profit before tax 3542 2529 1936
Inflation factor 1.000 1.064 1.132
Present value of brand profits 3542 2690 2192
Weightage factor 3 2 1
Weighted average profits 3033
Remuneration of capital 457
Brand related profits 2576
Tax 867
Brand earnings 1709
Brand multiple 18.50
Brand value 31617
Thank You