Mergers and Acquisitions – Strategic Considerations

Mergers and Acquisitions – Strategic Considerations

blog

Apr 19

2019

Posted by: CS Shilpi Thapar

A Quote from Mr. Dhirubhai Ambani: “Dream   &   Dare. Let no one demoralize you. Do  not  allow  any  one to  deter you .Pursue  you  goal , even  in  the  face  of difficulties.   Convert   Difficulties   into opportunities.  Keep your morale high in spite of setbacks. At the end you are bound to succeed.”

Palmer’s Quotation:

“Companies frequently require rearranging their capital structure.  There may be  cases where  some  minority  shareholders  oppose the  proposals  or  it  may  not  be possible to trace all the shareholders. In these events   it    is  necessary  to  have  a  method  by  which dissentient or  untraced shareholders do  not render   the   arrangement   impossible   but become bound by it………”

History:-

Mergers and Acquisitions activity was not so popular in Indian corporate world in the Pre – 90’s.

The budget of 1991 opened such opportunities in terms of:-

  • Consolidation to achieve economies of scale.
  • Diversification / In organics growth opportunities
  • Foreign Companies entry through existing Indian Players

This objective were narrated in the Budget Speech 1999-2000 by Yashwant  Sinha as:

“With Growing liberalization of the economy,   there is a need for industrial restructuring so that companies can focus better on their core activities…………..”

  I therefore, introduce a flexible fiscal policy for regulating business reorganizations in a fully Tax neutral manner.

  It is proposed that all fiscal concessions will survive for the unexpired period in the case of Amalgamation and Demerger……..”

 

What is Merger & Acquisitions?

Merger : 

A Transaction where two firms agree to integrate their operations on a relatively co-equal basis because they have resources and capabilities that together may create a strongest competitive advantage.

Acquisition :

A transaction where one firm buys another firm with the intent of more effectively using a core acquired firm a subsidiary within its portfolio of businesses. An acquisition where the target firm did not solicit the bid off the acquiring firm.

 Why Merger & Acquisitions?

 Rationales & Motives that drive Merger & Acquisitions:

  • Buy under performing businesses domestically (at current levels) wherein buyer has capabilities to derive upsides.

               Wockhardt Merind

                Dabur Balsara

              Reliance’s acquisitions of 90’s

  • Buy under performing businesses overseas wherein buyer has restructuring capabilities.

               Some of the European Pharma’s acquisitions by India Companies.

              Asian Paint’s acquisitions in emerging markets.

             Recent auto components / engineering acquisitions in Europe by Indian Companies.

  • Buy businesses/ companies which allow you to expand in different methods overseas.

              Indian Pharma’s overseas acquisition

             Various acquisitions by Tata (Corus)

  •  Buy businesses/companies which gives you access to lucrative customer relationship.
  • Buy established premium retail brands in developed markets to move up the value chain.

            Welspun’s acquisition of UK’s Christy

  • Buy competition with complimentary business models, diversity in the same value chain.

              Kingfisher / Deccan deal

  • Buy a company which gives you wider domestic reach/pan India presence.

              Cellular acquisition of Bharti

             Cement company’s acquisition

  • Buy a business which gives you a parallel distribution network.

             HLL modem

  • Buy a direct competitor who is debt ridden

             Nirma Saurashtra Chemicals

             Everyday BPL Batteries

  • Buy a goal plant/and from a debt ridden /under performing company.
  • “India Entry” with a leader

               Matsushita Anchor

               DHL Blue dart

              Holcim Acc Gujarat Ambuja

             Vodafone Bharti & Vodafone Hutchison  Essar

             Lavazza Barista

  • Buy an “India exit” candidate

              Nicholas Piramal acquisitions

              Zydus Cadila – German Remedies

  • Strategic use of capabilities/resources

             Barter model of Bennett & Coleman ( pantaloons, Hakoba, Today’s  Videocon)

            Gujarat Ambuja’s earlier Rs. 60 crore investment (15% Stake) in ING Vyasya Life Insurance Company Ltd.

  • Acquisition to enhance / complete portfolio of products.

            Acquisition of Sesa Goa by Vedanta was to enter the ferrous metals  range.

            Acquisition of Himalayan by Tata tea (Complete beverage solutions Company)

  • Synergies of distribution base

              Future group’s investment in Sula Wines

              Indian Hotel/Tata Group’s acquisition of  “Sumeru”

  • Acquisitions to take advantage of lower costs in the supply chain

              Acquisition by M & M to lower manufacturing costs, Tractor Company in China.

  • Acquisitions to get easier regulatory approvals.

              Acquisitions of various Shells NBFCs by lending funds.

Mergers & Acquisitions Process:

  1. Strategic Intent: Clearly laid out objectives of doing the merger/integration/JV & statement of desired benefits/synergies.
  1. Target identification & analyzing fit: Generation of Merger & Acquisition leads (both internal & external and analyzing the fit with the strategic intent).
  1. Setting up project team: Selection of project leader, steering committee and the implementation teams.
  1. Due Diligence: Due diligence (operation/financial/legal) leading to financial modeling to arrive at deal value.
  1. Structuring, valuations & negotiations: Valuation of the target structuring and closure of deal.
  1. Integration: A detailed activity chart with timeless and milestones, integration with parent company in terms of finance , IT, HR, and compliance, setting up the review process, planning for communication and management of HR issues.

 Types of Mergers:

  • Horizontal Merger – Two companies that are in direct competition and share the same product lines & markets.
  • Market Extension Merger – Two companies that are selling the same products in different markets.
  • Product Extension Merger – Two companies selling different but related products in the same market.
  • Vertical Merger – A customer & company or a supplier and company.
  • Conglomeration – Two companies that have no common business areas.

 Based on mode of discharging consideration:

  • Purchase mergers – Purchase is made with cash or through issue of some kind of debt instrument.
  • Consolidation merger – A brand new company is formed and both companies are brought and combined and under the new entity where consideration is discharged by issue of shares.

      Types of Acquisitions: 

  • Like mergers, acquisitions are actions through which companies seek economies of scale, efficiencies and enhanced market visibility.
  • All acquisitions involve one firm purchasing another – that is no exchange of stock or consolidation as a new company.
  • Smaller acquisition deals – one company to acquire all the assets of another company – acquire company become merely a Shell and will eventually liquidate or enter another areas of business.
  • Reverse Merger – occurs when private company that has strong prospects and is eager to raise finance buys a public ally listed Shell Company usually one with no business and limited assets.

Synergies in Mergers & Acquisitions:

  • Synergies are the force that allows for enhanced costs efficiencies of new business.
  • Most commonly sought  Synergies  are:

             – Staff reduction

            – Economies of scale

            – Technology acquisition

             – Improved market research & Industry   visibility

  • Acquiring companies pay substantial premium on the stock market values of the company as value for synergy.
  • A merger benefits shareholders when a company’s post – merger share price increases by the value of potential synergy.
  • Minimum required strategy ( Pre-merger value of both firms + synergy of post merger number of shares) = post merger stock price.
  • Revenue enhancement
  • Cost reduction
  • Tax gain
  • Incremental new investment required in working capital and fixed assets.

Legal Dimensions:

Following Statutory Acts are applicable to Merger & Acquisitions Deal –

a) The Companies Act, 1956

b) SEBI Provisions

c) Income Tax Act, 1961

d) Stamp Act

e) Competition Act

f) Sick Industrial Companies (Special Provisions Act)

g) Effects of Contracts

h) FEMA

i) Service Tax

j)  DTA

k)Treaty Shopping   mirthful

l) Press Notes by Ministry of Commerce

THE COMPANIES ACT,1956: 

  • The Companies Act ,1956 doesn’t expressly define “Amalgamation” or “Merger” and doesn’t deal with “Acquisition”
  • Section 391-394 applies.
  • General Procedure: How to go about?

1. Net worth               – Calculations

2.  Exchange Ratios –   Fixing up

3.  Scheme Details   –   Working out

4.  General Meeting   –   Convening

5.  Approval               –   By General Body

6.  Court                     –   Sanction

7.  Scheme effective   –   Appointed Date

Meeting of Creditors – in case of healthy companies not necessary.

Notice to ROC & RD and Liquidators Report is required in order to get approval from Court.

  • OPTIONAL PROVISIONS IN A SCHEME: 

 – Change of name- quite often used in reverse merger particularly where the transferor company has valuable leasehold/tenancy property or substantial goodwill.

 –  Change in Object Clause in the MOA of Transferee Company.

– Increase in Authorized Capital of the Transferee Company.

– Amendment of Articles of Association of the Company.

THE INCOME TAX ACT, 1961: 

  • Amalgamations defined under section 2(1B) of The I.T Act, 1961. These definitions only for specific purposed of Income Tax Act.
  • Sec.72A of The I.T Act, 1961 deals with carried forward and setoff of accumulated losses and unabsorbed depreciation allowance of the transferor company to be the loss/allowance for depreciation of the amalgamated company for the previous year in which amalgamation effected.
  • Applies only where Transferor Company owns industrial undertaking or ship or hotel or is a banking company.
  • Sec.72A(1) w.e.f 1.04.2008 applicable to public sector company in the business of operations of aircrafts.

Conditions under Sec.72A:

  – Amalgamating company should be in the business for 3 or more years.

– Continuously held at least 3/4th of book value of fixed assets held 2 years prior to date of amalgamation.

 – Transferee company has to hold at least 3/4th of the Book Value of fixed assets of transferor for at least 5 years.

  – Prescribed conditions to be fulfilled to ensure- revival of business of Transferor Company or amalgamation is for genuine business purpose.

  • If any condition not fulfilled, set off losses or allowance deemed to be income of the transferee company in the year when condition is not fulfilled.
  • Scheme designed to evade tax not to be approved by court. If purpose of scheme is not to evade tax but merely because that may be the result, court will not reject a scheme.
  • In case of Wood Polymer Ltd , Gujarat High Court refused to sanction a scheme which it found to have been made solely to facilitate the transfer of a building without attracting liability to pay capital gain tax.
  • Capital Gain exemption to company is available u/s. 47(vi) and to shareholders u/s. 47(vii).

STAMP DUTY

  • Stamp Acts of almost all states now provide for the payment of stamp duty on amalgamation. Prior thereto a lot of disputes regarding the liability for stamp duty.
  • Definition of “Conveyance” includes order made by High Court under Sec.394 of The Companies Act, 1956.
  • In States like Maharasthra and Gujarat, the amount of duty linked to the market value of shares allotted and/or other consideration paid for the amalgamation and on immovable property of the transferor company.
  • In Maharasthra in case of merger of subsidiary with the holding company, since no shares to be issued, no stamp duty is payable.
  • Where immovable properties of the transferor company located in more than one state, differential duty would be payable in the state where the immovable property is situated.
  • In some states in practice no duty is paid on the ground that the transfer of the property of transferor company to transferee company takes place as a result of operation of law.

COMPETITION ACT

  • Provisions attracted if merger is likely to cause an appreciable adverse effect on competition within the relevant market in India. Renders it void.
  • Parties can approach the commission for approval of the proposed merger.

SICA

  • Section 18 of SICA, empower BIFR to sanction scheme for amalgamation of sick company with another sick company or even a healthy company with a sick company.
  • Before sanctioning such a scheme, the approval by a special resolution passed by the meeting of the shareholders of the transferee company is required.

EFFECTS ON CONTRACTS: 

  • Section 15(g) of The Specific Relief Act empowers the amalgamated company to obtain specific performance of a contract entered into by the transferor company, if such contract is otherwise capable of specific performance.
  • Contracts which under any law require consent of other party for assignment cannot be transferred upon amalgamation unless such consent obtained. Eg: Tenancy.
  • Certain Statutory license don’t get transferred get transferred automatically upon amalgamation Eg: License issued by Dept. of  Telecommunications.

VALUATION:

What is Value?

  • Depends on Who is asking and Why?
  • Generally an economic concept where what a buyer is willing to pay and what a seller is willing to take overlap.

What creates Value?

 –        Cash Flow: i.e  Dividend declared, timing of cash receipts.

–          Assets : Operating and Non operating assets like Cash Balance for Investments.

Value has no statutory definition. It depends on purpose & timings of valuation.
Valuation Methodologies:

1. Asset Based Models:

– Book Value: Considers value of assets and liabilities as per the Books.

– Replacement value: considers the value of replacing the assets and liabilities of the operating business.

– Liquidation value: considers the value that can be generated by liquidations of assets.

2.  Market Based Models:

Based on market quotation i.e current market price, comparable price i.e price of comparable company and comparable transaction i.e method provides a more appropriate value based on transactions in the recent past.

3. Earning Based Models:

– The value is determined by future earning potential.

4. Cash Flow Based Models:

 It is based on principle of the availability of free cash for distribution to the capital providers.

– Discounted Cash Flow (DCF) Method is used and most effective and popular method.

Consideration:

  • Shares:            Shares Swap Ratios
  • Cash :              Acquisition Price

The Shares swap ratio can be calculated as follows under various valuations:

The Shares swap ratio can be calculated as follows under various valuations:

–          Based on Earnings: EPS of Target Firm/EPS of Acquiring Firm

–          Based on Market price: MP of Target firm’s Share/ MP of Acquiring Firm’s Share

–          Based on Asset Value: AV of Target Firm/AV of Acquiring Firm.

FAILURE OF MERGERS & ACQUISTIONS:

However, its not all Rosy!

“ With the Catching, ends the pleasure of Chase”-  Abraham Lincoln

 Failures of Mergers & Acquisitions:

 Factors resulting in failure of Deals:

–          Speed

–          Cultural Mismatch

–          Global Complexities

–          Corporate Arrogance

–          Confusion on Authority

–          Enhancing Customer Focus

–          Retaining People- re-recruitment Plan

–          Communication and feedback through integration   i.e British Steel & Hoogovens to form Corus- M&A deal fail.

 HOW TO SUCCEED AT Mergers &Acquisitions:

–          Be prepared to walk away from a bad deal

–          Insist on high level management approval of all M&A

–          Use a compensation system to ward off ill-considered acquisition

–          Set a walk away price.

 

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