Chapter - 32

Corporate
Restructuring, Mergers
and Acquisitions
Chapter Objectives
Discuss the form of mergers and acquisitions.
Highlight the real motives of mergers and
acquisitions.
Illustrate the methodology for evaluating
mergers and acquisitions.
Focus on the considerations that are important
in the mergers and acquisitions negotiations.
Understand the implications and evaluation of
the leveraged buyouts.

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Introduction
Corporate restructuring includes mergers and
acquisitions (M&As), amalgamation, takeovers,
spin-offs, leveraged buy-outs, buyback of
shares, capital reorganisation etc.
M&As are the most popular means of corporate
restructuring or business combinations.

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 Types of Business Combination
Merger or Amalgamation
Merger or amalgamation may take two forms:
Absorption is a combination of two or more companies into
an existing company.
Consolidation is a combination of two or more companies
into a new company.
In merger, there is complete amalgamation of the
assets and liabilities as well as shareholders interests
and businesses of the merging companies. There is
yet another mode of merger. Here one company may
purchase another company without giving
proportionate ownership to the shareholders of the
acquired company or without continuing the business
of the acquired company.
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Types of Business Combination
Forms of Merger:
Horizontal merger
Vertical merger
Conglomerate merger
Acquisition may be defined as an act of
acquiring effective control over assets or
management of a company by another
company without any combination of
businesses or companies. A substantial
acquisition occurs when an acquiring firm
acquires substantial quantity of shares or
voting rights of the target company.

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Types of Business Combination
Takeover The term takeover is understood to
connote hostility. When an acquisition is a
forced or unwilling acquisition, it is called a
takeover.
A holding company is a company that holds
more than half of the nominal value of the equity
capital of another company, called a subsidiary
company, or controls the composition of its
Board of Directors. Both holding and subsidiary
companies retain their separate legal entities
and maintain their separate books of accounts.

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M&A in India

Deals
Amount
Year Number (Rs crore)
1998-99 292 16,071
1999-00 765 36,963
2000-01 1,177 32,130
2001-02 1,045 34,322
2002-03 838 23,106
2003-04 834 35,980

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Motives of Mergers and Acquisitions
Mergers and Acquisition are intended to:
Limit competition.
Utilise under-utilised market power.
Overcome the problem of slow growth and
profitability in ones own industry.
Achieve diversification.
Gain economies of scale and increase income with
proportionately less investment.
Establish a transnational bridgehead without
excessive start-up costs to gain access to a foreign
market.

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Motives and Benefits of Mergers
and Acquisitions
Utilise under-utilised resourceshuman and physical
and managerial skills.
Displace existing management.
Circumvent government regulations.
Reap speculative gains attendant upon new security
issue or change in P/E ratio.
Create an image of aggressiveness and strategic
opportunism, empire building and to amass vast
economic powers of the company.

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Benefits of Mergers and Acquisitions
The most common advantages of M&A are:
Accelerated Growth
Enhanced Profitability
Economies of scale
Operating economies
Synergy
Diversification of Risk

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Benefits of Mergers and Acquisitions
Reduction in Tax Liability
Financial Benefits
Financing constraint
Surplus cash
Debt capacity
Financing cost
Increased Market Power

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Analysis of Mergers and Acquisitions
There are three important steps involved in the
analysis of mergers or acquisitions:
Planning
Search and screening
Financial evaluation

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Value Creation Through Mergers
and Acquisitions
Merger will create an economic advantage (EA)
when the combined present value of the
merged firms is greater than the sum of their
individual present values as separate entities.
Net economic advantage = Economic advantage Cost of merger/acquisition
NEA [VPQ (VP VQ )] (cash paid VQ )

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Valuation under Mergers and
Acquisitions: DCF Approach
In order to apply DCF technique, the following
information is required:
Estimating Free Cash Flows
Revenues and expenses
Capex and depreciation:
Working capital changes
Estimating the Cost of Capital
Terminal Value

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Financing a Merger
Cash Offer:
A cash offer is a straightforward means of financing a merger.
It does not cause any dilution in the earnings per share and the
ownership of the existing shareholders of the acquiring
company.
Share Exchange:
A share exchange offer will result into the sharing of ownership
of the acquiring company between its existing shareholders
and new shareholders (that is, shareholders of the acquired
company). The earnings and benefits would also be shared
between these two groups of shareholders. The precise extent
of net benefits that accrue to each group depends on the
exchange ratio in terms of the market prices of the shares of
the acquiring and the acquired companies.
The bootstrapping phenomenon.

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Merger Negotiations: Significance
of P/E Ratio and EPS Analysis
The mergers and acquisitions decisions are also
evaluated in terms of EPS, P/E ratio, book value etc.
Share Exchange Ratio
The share exchange ratio (SER) would be as follows:
Share price of the acquired firm Pb
Share exchange ratio
Share price of the acquiring firm Pa
The exchange ratio in terms of the market value of
shares will keep the position of the shareholders in
value terms unchanged after the merger since their
proportionate wealth would remain at the pre-merger
level.

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 Merger Negotiations: Significance
of P/E Ratio and EPS Analysis
No. of shares exchanged SER Pre-merger number of shares of the acquired firm
( Pb / Pa ) N b 0.25 4,000 1, 000
Post-merger combined PAT PATa PATb
Post-merger combined EPS =
Post-merger combined shares N a (SER) N b

Post-merger weighted P/E ratio:

(Pre-merger P/E ratio of the acquiring firm) (Acquiring
firms pre-merger earnings Post-merger combined
earnings) + (Pre-merger P/E ratio of the acquired firm)
(Acquired firms pre-merger earnings Post-merger
combined earnings)
P/E w (P/E a ) (PATa / PATc ) (P/E b ) (PATb / PATc )

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Merger Negotiations: Significance
of P/E Ratio and EPS Analysis
Earnings Growth
The formula for weighted growth in EPS can
be expressed as follows:
Weighted Growth in EPS = Acquiring firms
growth (Acquiring firms pre-merger
PAT/combined firms PAT) + Acquired firms
growth (Acquired firms pre-merger
PAT/combined firms PAT).
PATa PATb
gw ga gb
PATc PATc

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Factors Influencing the Earnings
Growth
The important factors influencing the earnings
growth of the acquiring firm in future are:
The priceearnings ratios of the acquiring and the acquired
companies.
The ratio of share exchanged by the acquiring company for
one share of the acquired company.
The pre-merger earnings growth rates of acquiring and the
acquired companies.
The level of profit after tax of the merging companies.
The weighted average of the earnings growth rates of the
merging companies.

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Leveraged Buy-outs
A leveraged buy-out (LBO) is an acquisition of a
company in which the acquisition is substantially
financed through debt. When the managers buy their
company from its owners employing debt, the leveraged
buy-out is called management buy-out (MBO).
The following firms are generally the targets for LBOs:
High growth, high market share firms
High profit potential firms
High liquidity and high debt capacity firms
Low operating risk firms
The evaluation of LBO transactions involves the same
analysis as for mergers and acquisitions. The DCF
approach is used to value an LBO.

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Tender Offer and Hostile Takeover
A tender offer is a formal offer to purchase a
given number of a companys shares at a
specific price.
Tender offer can be used in two situations.
First, the acquiring company may directly
approach the target company for its takeover. If the
target company does not agree, then the acquiring
company may directly approach the shareholders
by means of a tender offer.
Second, the tender offer may be used without any
negotiations, and it may be tantamount to a
hostile takeover.

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Defensive Tactics
Divestiture
Crown jewels
Poison pill
Greenmail
White knight
Golden parachutes

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Regulation of Mergers and
Takeovers in India
In India, mergers and acquisitions are
regulated through:
The provision of the Companies Act, 1956,
The Monopolies and Restrictive Trade Practice
(MRTP) Act, 1969,
The Foreign Exchange Regulation Act (FERA),
1973,
The Income Tax Act, 1961, and
The Securities and Controls (Regulations) Act, 1956.
The Securities and Exchange Board of India (SEBI) has
issued guidelines to regulate mergers, acquisitions and
takeovers.

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Regulation of Mergers and
Takeovers in India
Legal Measures against Takeovers
Refusal to Register the Transfer of Shares:
a legal requirement relating to the transfer of shares have
not be complied with; or
the transfer is in contravention of the law; or
the transfer is prohibited by a court order; or
the transfer is not in the interests of the company and the
public.
Protection of Minority Shareholders Interests
SEBI Guidelines for Takeovers:
Disclosure of share acquisition/holding
Public announcement and open offer
Offer price
Disclosure
Offer document

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Legal Procedures
Permission for merger
Information to the stock exchange
Approval of board of directors
Application in the High Court
Shareholders and creditors meetings
Sanction by the High Court
Filing of the Court order
Transfer of assets and liabilities
Payment by cash or securities

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Accounting for Mergers and
Acquisitions
Pooling of Interests Method
In the pooling of interests method of accounting,
the balance sheet items and the profit and loss items
of the merged firms are combined without recording
the effects of merger. This implies that asset,
liabilities and other items of the acquiring and the
acquired firms are simply added at the book values
without making any adjustments.
Purchase Method
Under the purchase method, the assets and
liabilities of the acquiring firm after the acquisition of
the target firm may be stated at their exiting carrying
amounts or at the amounts adjusted for the purchase
price paid to the target company.
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