Mergers and Acquisitions

Restructure

• Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs.

Con..

Reasons for restructuring –

• change of ownership or ownership structure

• merger, demerger, acquisition and consolidation.

• response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout.

Merger, consolidation and Amalgamation

A merger is said to occur when two or more business combine into new one.This can happen through absorption of existing companies.A consolidation, which is a form of merger, a new company is formed to takeover existing business of two or more companies.In India, mergers are called amalgamations in legal parlance.

Acquisition and Takeover• An acquisition is the purchase of one business or company by another

company or other business entity.• A acquisition is a combination of two or more corporations in which only

one corporation survives and the merged corporations go out of business.

• Statutory acquisition is a merger where the acquiring company assumes the assets and the liabilities of the acquired or target company .

• A subsidiary acquisition is a merger of two companies where the target company becomes a subsidiary or part of a subsidiary of the parent company

• The takeover refers to the acquisition of controlling interest in an existing company. A takeover is same as acquisition, except that a takeover has a flavor of hostility in majority of cases.

Takeover can be

Hostile Takeover A takeover attempt that is strongly resisted by the

target firm.

Friendly Takeover Target company's management and board of

directors agree to a merger or acquisition by another company

Examples of Acquisition• Lipton India is acquired by Brooke Bond.

• Bank of Mathura and Bank of Rajasthan is purchased by ICICI Bank.

• BSES Ltd purchased Orissa Power Supply Company.

• Associated Cement Companies Ltd has acquired Damodar Cement.

Demerger Spin off and Spin out

• The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one company splits into two, generating a second company separately listed on a stock exchange.

Con.. :Market Impact

• Demergers tend to go in and out of fashion. • When share prices are rising, companies like to

use their ‘paper’ (shares) to acquire other companies, so their advisers encourage merger activity.

• In a market of falling prices, mergers and IPOs are less popular, and the merchant banks that earn their fees from corporate activity will start to look at demerger possibilities for their clients.

Con.. :Tax Liability

• From a tax point of view, when a company splits into two or more parts and distributes shares in each part to its original shareholders, there is no disposal for capital gains tax purposes.

Types of mergers

• Vertical Merger

• Horizontal Merger

• Conglomerate Merger

• Cross boarder Merger

Vertical merger

• A vertical merger is one of the most common types of mergers. When a company merges with either a supplier or a customer to create an extension of the supply chain, it is known as a vertical merge or integration.

• Ex:Oracle’s purchase of Sun Microsystems and PepsiCo’s acquisition of two of its bottlers.IBP and IOC merger.

Con…Horizontal mergers are types of mergers that involve

companies in direct competition with one another. Often horizontal mergers are considered hostile, which means a larger company "takes over" a smaller one in more of an acquisition than a merger.

Buying a competitorGlaxosmithkline mergerAT&T merger into SBC enables the latter to access the

corporate customer base and exploit the predictable cash flows typical of this telephony section

• Conglomerate mergers are types of mergers that are in different market businesses. There is no relationship between the type of business one company is in and the type the other is in. The merger is typically part of a desire on the part of one company to grow its financial wealth.

• EX: Walt Disney Company and the American Broadcasting Company.

• TATA-AIG insurance co ltd.• AOL and Time Warner inc. Merger.

Cross Boarder

• Cross-border Mergers and Acquisitions (M&As) are defined as the joining of two firms or the takeover of one firm by another when the parties involved are based in different national economies.

• In some instances, M&As between foreign affiliates and firms located within the same country are included.Corus group Plc. And Tata steel

Mergers and acquisition in India

• The volume of merger and acquisition deals in India had manifested three-folds to USD 67.2 billion in 2010 from USD 21.3 billion in 2009.

• Now, in 2011, M&As in India surged a whopping 270 percent in the first three months alone.

• India has emerged into the one of the top countries in the M&A deals.

Top 10 cross border acquisitions made by Indian companies worldwide:

Acquirer Target Company Country targeted Deal value ($ ml) Industry

Tata Steel Corus Group plc UK 12,000 Steel

Hindalco Novelis Canada 5,982 Steel

Videocon Daewoo Electronics Corp. Korea 729 Electronics

Dr. Reddy’s Labs Betapharm Germany 597 Pharmaceutical

Suzlon Energy Hansen Group Belgium 565 Energy

HPCL Kenya Petroleum Refinery Ltd. Kenya 500 Oil and Gas

Ranbaxy Labs Terapia SA Romania 324 Pharmaceutical

Tata Steel Natsteel Singapore 293 Steel

Videocon Thomson SA France 290 Electronics

VSNL Teleglobe Canada 239 Telecom

Benefits of merger

• Diversification of product and service offerings. AOL and TIME WARNER merger -Time Warner the

world's largest media and AOL online services company.

• Increase in plant capacity

• Reduction of financial risk

Con..

• Larger market share • Utilization of operational expertise and research and

development (R&D) • Example:UK based pharmaceutical companies Glaxo

Wellcome and SmithKline Beecham - Glaxo SmithKline is the largest drug company. The National Health Service in Britain refuses to prescribe a drug if it is too expensive. Rising research and development costs have meant that drug companies have been unable to “go it alone” and have had to utilise the expertise and resources of other drug companies in order to survive in a cut-throat market.

SummaryMerger

– The combination of two firms into a new legal entity– A new company is created– Both sets of shareholders have to approve the

transaction.Amalgamation

– A genuine merger in which both sets of shareholders approved the transaction

– Requires a fairness opinion by an independent expert on the true value of the firm’s shares when a public minority exists

Takeover– The transfer of control from one ownership group to

another.Acquisition

– The purchase of one firm by another firm.

Top Acquisitions by other than Indian companies

Rank Year Purchaser Purchased Transaction value (in mil. USD)

1 2000America Online Inc. (AOL)

Time Warner 164,747

2 2000Glaxo Wellcome Plc.

SmithKline Beecham Plc.

75,961

3 2004Royal Dutch Petroleum Co.

Shell Transport & Trading Co

74,559

4 2006 AT&T Inc.BellSouth Corporation

72,671

5 2001Comcast Corporation

AT&T Broadband & Internet Svcs

72,041

6 2004Sanofi-Synthelabo SA

Aventis SA 60,243

7 2000Spin-off: Nortel Networks Corporation

59,974

8 2002 Pfizer Inc.Pharmacia Corporation

59,515

9 2004JP Morgan Chase & Co

Bank One Corp 58,761

Need of Mergers , Acquisitions &

Takeovers

Benefits of merger

• Diversification of product and service offerings

• Monopoly

• Increase in plant capacity

• Larger market share

• Utilization of operational expertise and research and development (R&D)

• Reduction of financial risk

Why do mergers fail ?

• Lack of human integration• Mismanagement of cultural issues• Lack of communication

SYNERGIES RELATED TO ACQUISITION

• Economies of scale

• Staff reductions

• Acquiring new technology

• Improved market reach and industry visibility

• Taxation

.

Two companies that are recognized as among the best at making successful acquisitions are General Electric and Cisco Systems. These companies have been star performers in growing shareholder value. The core principal that runs through almost every acquisition is integration. Over the past 10 years Cisco Systems has acquired 81 companies. Their stock price is up a remarkable 1300%. GE outperformed the S&P 500 index over the same period by 300%. There are several categories of strategic acquisition that can produce some outstanding results:

WHY SHOULD FIRMS TAKEOVER?

• To gain opportunities of market growth more quickly than through internal means

• To seek to gain benefits from economies of scale • To seek to gain a more dominant position in a national or

global market • To acquire the skills or strengths of another firm to

complement the existing business • To acquire a speedy access to revenue streams that it

would be difficult to build through normal internal growth • To diversify its product or service range to protect itself

against downturns in its core markets

Need of Merger and Acquisition

ACQUIRE CUSTOMERS - this is almost always a factor in strategic acquisitions. Some companies buy another that is in the same business in a different geography. They get to integrate market presence, brand awareness, and market momentum

OPERATING LEVERAGE - the major focus in this type of acquisition is to improve profit margins through higher utilization rates for plant and equipment. A manufacturer of cardboard containers that is operating at 65% of capacity buys a smaller similar manufacturer. The acquired company's plant is sold, all but two machines are sold, the G&A staff are let go and the new customers are served more cost effectively.

• CAPITALIZE ON A COMPANY STRENGTH - this is why Cisco and GE have been so successful with their acquisitions. They are so strong in so many areas, that the acquired company gets the benefit of many of those strengths. A very powerful business accelerator is to acquire a company that has a complementary product that is used by your installed customer base. Management depth and skill, production efficiency/ capacity, large base of installed accounts, developed sales and distribution channels, and brand recognition are examples of strengths that can power post acquisition performance.

•

• COVER A WEAKNESS - This requires a good deal of objectivity from the acquiring company. Let me help you with some suggestions - 1. Customer concentration; 2. Product concentration; 3. Weak product pipeline; 4. Lack of management depth or technical expertise and 5. Great technology and products - poor sales and marketing.

•

• BUY A LOW COST SUPPLIER - this integration strategy is typically aimed at improving profit margins rather than growing revenues. If your product is comprised of several manufactured components, one way to improve corporate profitability is to acquire one of those suppliers. You achieve greater control of overall costs, availability of supply, and greater value-add to your end product .

IMPROVING OR COMPLETING A PRODUCT LINE - this approach has several elements from other acquisition strategies. Successfully adding new products to a line improves profitability and revenue growth. Giving a sales force more "arrows in their quiver" is a powerful growth strategy. You take advantage of your existing sales and distribution channel (strength). You may be able to improve your competitive position by simplifying the buying process - providing your customers one stop shopping.

•

• TECHNOLOGY - BUILD OR BUY? This is a quandary for most companies, but is especially acute for technology companies. Acquiring technology through acquisition can be an excellent growth strategy. The R&D costs are generally lower for these smaller, agile, more narrowly focused companies than their larger, higher overhead acquirers. Time to market, window of opportunity, first mover advantage can have a huge impact on the ultimate success of a product. First one to establish their product as the "standard" is the big winner.

• EX:BP and Reliance Industries transformational partnership in India. BP will pay Reliance Industries an aggregate consideration of $7.2 billion BP to take a 30 per cent stake in 23 oil and gas blocks. Formation of a 50:50 joint venture between the two companies for the sourcing and marketing of gas.

• Future performance payments of up to US$1.8 billion could be paid• These payments and combined investment could amount to US$20 billion

• ACQUISITION TO PROVIDE SCALE AND ACCESS TO CAPITAL MARKETS - In this area, bigger is better. Larger companies are considered safer investments. Larger companies command larger valuation multiples. Some companies make acquisitions in order to get big enough to attract public capital in the form of an IPO or investments from Private Equity Groups.

• PROTECT AND EXPAND MATURE PRODUCT LINES - This has been very effectively done in the pharmaceutical sector where a new technology is acquired to reprocess and re patent drugs.

• PROTECT CUSTOMER BASE FROM COMPETITION - The telephone companies have done studies that show that with each additional product or service that a customer uses, the likelihood of the customer attracting toward a competitor drops exponentially. Get your customers to use local, long distance, cellular, cable, broadband, etc and you will not lose them. Multiple products and services provided to the same customer dramatically improve retention rates.

• ACQUISITION TO REMOVE BARRIERS TO ENTRY - For example, a large commercial IT consulting firm acquires a technology consulting firm that specializes in the Federal Government. The larger IT consulting firm has valuable expertise that is easily transferable to government business if they could only break the code of the vendor approval process. After many fits and starts, they simply acquired a firm that had an established presence. They were able to then bring their full capabilities from the commercial side to effectively increase their newly acquired government business.

• Resource transfer: resources are unevenly distributed across firms and the interaction of target and acquiring firm resources can create value through either overcoming information asymmetry or by combining scarce resources.

• Ex: ICICIC Bank has purchased Rajasthan bank to have their resources i.e. branches.

Top 10 acquisitions made by Indian companies worldwide:

Acquirer Target Company Country targeted Deal value ($ ml) Industry

Tata Steel Corus Group plc UK 12,000 Steel

Hindalco Novelis Canada 5,982 Steel

Videocon Daewoo Electronics Corp. Korea 729 Electronics

Dr. Reddy’s Labs Betapharm Germany 597 Pharmaceutical

Suzlon Energy Hansen Group Belgium 565 Energy

HPCL Kenya Petroleum Refinery Ltd. Kenya 500 Oil and Gas

Ranbaxy Labs Terapia SA Romania 324 Pharmaceutical

Tata Steel Natsteel Singapore 293 Steel

Videocon Thomson SA France 290 Electronics

VSNL Teleglobe Canada 239 Telecom

• Accelerate value creation, manage risk during acquisitions• After only nine months, it had become clear to the CEO that a company they acquired had fallen significantly short of sales

projections. An acquisition that looked so promising didn't pan out, and had forced the company to make significant changes to adjust. Given that the company has an aggressive plan to grow through acquisition, the CEO determines he cannot make the same mistake again.

• The CEO turned to Walker to help "fix" this new, underperforming asset and to ensure the success of future mergers.• Even though customers are a company's most valuable asset, rarely does an acquiring company fully invest in understanding

the risks inherent in the target customer base prior to closing. In today's marketplace, the need for understanding and mitigating significant risks prior to the completion of any transaction is becoming increasingly important. Informed acquiring companies develop more accurate revenue and cost-saving projections and execute more customer-focused integration plans.

• Walker helps companies understand: • If the customer base is primed for growth

• How much revenue and how many customers are at risk of leaving

• How loyal are customers to the target company

• How customers view the target company vis-à-vis its competition

• What steps should be taken to optimize the value and stability of the customer base

Pac-Man defense• Scare off by purchasing large amounts of the acquiring

company's stock.• Resisting company may even sell off non-vital assets to

procure enough assets to buy out the acquirer.

Example Attempted acquisition of Martin Marietta by Bendix

Corporation in 1982 :•  Martin Marietta's management responded to takeover

attempt by selling non-core businesses in order to attempt a takeover of its own - of Bendix Corporation. In the end

• Bendix Corporation was bought by Allied Corporation

Indian outbound deals since 2000

William Durant, the founder of General Motors, lost control of his company due to his aggressive expansion plans. Going wholeheartedly from a carriage manufacturer to an automotive force, Durant used debt to finance his takeovers and mergers with other auto startups. The bankers, who helped with refinancing efforts, and the stockholders, to whom Durant had sold and resold shares, finally decided to oust him and consolidate current holdings, rather than to continue the breakneck expansion.

Durant immediately began to look for a way to regain control of his company. He hooked up with a Swiss racer named Louis Chevrolet and the two formed Chevrolet. Although Durant soon disagreed with Chevrolet about the direction of the company and bought him out, the company was highly successful. Durant still held a large amount of GM stock and he used the profits from his new company to buy even more.

Durant eventually owned enough GM stock to bring the company to the table for merger/buyout talks. Durant offered a five-for-one stock swap. GM shareholders jumped at the chance to get another popular brand under their umbrella at a cheap price. GM particularly relished merging with a brand that could help it fight off Ford. As part of the deal, Durant regained control of the company he had founded.

Why merger and acquisition fails

• “Any idiot with a cheque book can buy a business”. The art is in buying the right one at the right price and knowingly what you want to do with it.

• More than 61% of the merger and acquisition are not successful.

• The major reasons as to why merger and acquisitions fail

•1. Over estimating the value of the target companyThough the basic aim of a company in merger and acquisition is to provide benefit to the shareholders and maximize its profits but in reality most of the companies are not able to achieve this. many parent companies often over estimate the value of their target company due to lack of due diligence. Also, sometimes, two or more companies are interested in acquiring the same company and this greatly shoots up the amount they eventually have meat out for the target company.

• ExampleDamlier-Benz and Chrysler GroupIn 1998 the German auto car maker Damlier Benz merged with Chrysler Group for a value of $36 billion. It was considered to be a win-win situation for both companies as it was perceived to be a merger between equal. However, after a few years, the value of Chrysler fell to a mere $7.4 billion. The merger had proved to be a failure. It over estimated the value of the target company which led to merger proving to be unsuccessful.

• TATA STEEL

Tata steel has paid control premium to acquire Corus. Expected synergy was roughly 300 mn USD, but in actual it was 76 mn USD in 2008.

• 2. High cost debt-The acquirer many a time’s gets submerged in large and extra ordinary debts during merger and acquisition. Most of the mergers and acquisitions are financed through unsecured debts which carry a huge rate of interest with them. These high cost debts eventually lead to a fall in the stock prices of the parent company. Also when two or more companies bid for the same company they may end up paying more for the target company. This over estimated price is usually raised by the company through high cost debts. As a result the company will try to cover these high cost debts which lead to a fall in the stock prices of the parent company which eventually hampers the company.

• ExampleIn 2008, Tata Motors acquired Jaguar. The analysts were of the opinion that it was Tata’s ambition to become a global company in quick time that led them to purchase Jaguar. Since a very high cost was paid, the deal was financed by Tata’s through high cost debts. Later the shares of both the companies suffered a huge blow as Tata tried to raise money to cover this huge acquisition debt

• 3. Job LossOne of the major reason as to why Mergers and Acquisitions is feared amongst the employees is because of job loss. According to the statistics provided, nearly 130,000 jobs have been lost as a result of mergers and acquisition in the European financial sector. Also according to the European Restructuring Monitor, of the 3.7 million job losses, approximately 240,000 jobs were lost as a result of mergers and acquisition. This job loss is mainly the result of the company going into cost cutting schemes to give some breathing space to its highly skewed balance sheet as a result of the merger or acquisition. The other reasons leading to job losses are -

a. company wanting to save on its pay roll

b. the parent company may already have surplus workmen

c. the target company may not be trading efficiently due to a large staff

• Examplea. In USA due to the merger between Chemical Bank and Chase Manhattan in 1995, nearly twelve thousand jobs were eliminated. Also when Nation Bank acquired Bank of America in 1998 it included plans to lay off nearly 18,000 employees.

b. The merger between UBS and SBS in Switzerland led to a job loss of 1385 employees

• 4. Cultural aspectThis is one of the biggest issues which the companies face during mergers and acquisition. No two companies can do the business in same way. The working and organization culture of every company is different. A company may be different from the other on the basis of the way they project themselves in the market, how they treat customers, suppliers and employees, how much freedom is given to the employees and so on. The merger or acquisition between two culturally different companies eventually leads to lower productivity if this issue is not addressed by the management right from the beginning.

• ExampleIn 1998, the German auto car maker Damlier Benz merged with US Chrysler Group. The deal was considered to be a win-win situation for both. However, after two years the company reported a huge loss because of which nearly 21,000 jobs were lost. One of the reasons given for this failed merger was that both these companies were fundamentally different with respect to their cultural background. Damlier-Benz was always known for its methodical organization, centralized decision making and a regard for tradition and hierarchy while Chrysler had a reputation of risk taking, encouraging creativity and flexibility.

• 5. Monopoly

A monopoly exists when a specific individual or an enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. A merger can lead to a monopoly where there are not many competitors in the market giving the parent company the power to control the price of the product and increase it according to will so as to increase their profit. As a result the bargaining power is shifted from the consumer to the producer. However, this situation can not arise anymore because of the stringent laws made by the government to check the menace of monopolies.

•ExampleMicrosoft of enjoying a huge power in the market for Intel compatible PCs. Their position in the market gave them the power to dictate the price in the market without any fear of losing customers.

• 6. Shareholders and Employees interest overlookedOne of the major mistake committed by the parent company is that it neglects the interest of the employees and the shareholders during due diligence. The shareholders who are being taken over often feel hostile. Mergers and acquisitions makes the employees shift their focus from productive work to issues related to conflicts, layoff, compensation etc. It also puts a huge question mark in the minds of the employees regarding their job security. It is required that during merger and acquisition a proper communication should be maintained between the management and the employees so as to avoid such issues.

• ExampleAs a result of the merger between ABB-Flakt at the global level, its branches in India also merged. However a study conducted on this merger in India revealed that no proper due diligence was conducted as a result of which the gain on the merger was less than the capital market growth due to which the shareholders of Flakt lost heavily.

The success rate of mergers and acquisition can be improved-• If all the aspects involved in merger and acquisition are given

proper attention. • It is to be borne in mind that a merger or an acquisition done

in haste cannot be successful. • Before a merger or an acquisition actually takes place a

thorough due diligence of the target company should be done.

• Based on that result the parent company should decide whether to go ahead with the merger or acquisition or not.

• You should plan to spend much time on the social and HR issues as on the financial, legal and business-systems issues.

AOL AND Time warner• When the merger was announced, analysts believed that Time

Warner's music, movies and magazines along with its cable systems would speed up AOL's transition from phone dial-up to broadband, and that AOL's Internet mentality would accelerate growth at Time Warner. Neither has occurred.

• Some benefits that AOL expected -- such as replacing Road Runner, Time Warner's broadband cable service -- did not materialize.

• Meanwhile, unexpected roadblocks -- such as internal pressures slowing AOL's efforts to make Internet telephone service commercially available -- unfortunately did. Instead of propelling AOL to new heights, the association with Time Warner has weighed AOL down, while its competitors, such as Google and Yahoo, have made important strides forward.

• At the time of the merger, there was great excitement about the innovation that would occur as the company's businesses collaborated to create new growth opportunities. Unfortunately, that "one company" strategy never got off the ground. Instead, each division "did its own thing." While that staved off turf wars, it did nothing to drive innovation. As a result, the company's growth has slowed, and the stock is now trading at about half what it was before merger ago.

• Time Warner has proven to be too big, too complex, too conflicted and too slow-moving -- in other words, too much like a classic conglomerate -- to seize new opportunities.

What AOL could have done if not mergered with TIME WARNER

• If AOL were independent, it would have its own stock, which it could use to compete with acquisitive companies like Yahoo Inc. that use their shares to buy innovative young companies -- the same approach that AOL employed in the 1990s when it acquired upstarts like ICQ and Mapquest. Even more importantly, it could adopt an aggressive strategy to build on its core strengths, without being slowed by bureaucracy or stymied by sister divisions. And it could reinvest its more than $1 billion a year of free cash flow, now diverted to other Time Warner operations, to assure itself of a brighter future.

Valuation of intangible assets

The value and importance of intangible assets are the driving force behind national and international mergers and are playing a greater role than ever before in terms of assets received through mergers, acquisitions and takeovers.

1 Intangible assets includes the traditional intellectual property assets such as patents, trademarks, copyrights, know-how and trade secrets and also recently included assets in this category such as mask-works and Internet domain names.

2 In the event of a merger or other type of corporate restructuring, the acquiring party should obtain equitable and record ownership of these intangible assets, acquire the appropriate license to use such intellectual property.

Importance of intangible assets may differ between industries and also amongst companies within a same industry.

For example, consumer products or retail businesses have higher level of marketing related intangible assets like brand as against industrial products where technology may play a more important role.

License and spectrum is a key intangible asset for telecom industry. Telecom deal prices would get impact by availability of license and spectrum.

Content library is a key intangible asset for transactions involving media companies.

Valuation methods

The 3 most common approaches in valuing intangible assets are:• Comparison approach,

• Cost approach.• Income approach and

comparison approach

• Valuation methods under the comparison approach determines the value of an intangible asset by reference to market activity like transaction prices, bids or offers involving identical or similar assets.

• Intangible assets are unique by their very nature , market data for comparison approach, if available at all, then also for similar but not identical assets and thereby requires certain adjustments.

• Since all relevant information is seldom available in public domain, this method becomes less relevant.

Cost approach

• In the cost approach, the value of an intangible asset is arrived at by calculating the cost of replacing it with an asset with similar or identical service capacity. It is generally used for valuation of workforce, computer software, websites, etc.

income approach

• Valuation methods under the income approach determine the value of an intangible asset, by reference to the present value of income, cash flows or cost savings that could actually or hypothetically be achieved by a market participant owning the asset. The methods generally used under the Income approach are royalty relief, premium profit and excess earnings.

Income approach The income method has three components – projected cash flows, the

economic life of the intangible asset , and the discount rate. Projected cash flows are the future income attributable to the intangible

asset. It is important that the analysis should capture all direct and indirect costs associated with the intangible asset including lost sales of products or services, incremental overhead costs, necessary investment and the likely effects of competition on the price premium or costs savings derived from the asset.

The economic life refers the to length of time that the intangible asset will be able to command the price or cost premium. The economic life is generally bounded by the legal life of the asset but is often much shorter. For instance, it is common in the electronics field for the technology to become obsolete in as little as 3 years, often well before the patent expires.

The discount rate refers to the expected cost of financing the asset in question. For intangible assets, the discount rates are generally quite a bit higher than the cost of capital of a company. It is similar to venture capital types of investments, with a corresponding discount rate from anywhere from 20% - 50% per year.

Excess earnings method The excess earnings method determines cash flows

attributable to the subject intangible asset after excluding the proportion of the cash flows that are attributable to other assets (say working capital, fixed assets).

this method is generally used in practice for those intangibles which have the biggest impact on the cash flows.

The contribution to cash flows made by assets other than the subject intangible asset is known as the ‘contributory asset charge’ or ‘economic rent’ and requires determining value of those assets first.

Premium profit method

• The premium profit method involves comparison of future profit streams/cash flows that would be earned by a business using the intangible asset with those that would be earned by a business that does not use the asset.

Royalty relief method

• The royalty relief method considers a hypothetical royalty payment saved through ownership as compared to licensing the asset from third party. Royalty rates are generally based on observed data in the same industry and typically applied as a percentage of revenues expected to be generated from the use of assets.

•

Con..

• Royalty relief method is popular for valuation of copy right, technical know-how etc.

• Excess earnings method is generally used to value customer related assets.

• Intangible asset valuation is relevant not only in M&As but also for financial and tax reporting.

Valuation of business

• Valuation is the process of estimating the market value of a financial asset and liability.

• Valuation is device to assess the worth of enterprise.

• Valuation of both the company is must for fixing the consideration amount to be paid in form of cash and share in M&A process.

• Valuations of both the companies help to safe guard the interest of the share holders in M&A process .

Valuation

Valuation of business depends upon-• Assets it carries• Equity share price • Projects in hand• Risk profile of different classes of business it

carries• Intangible asset it possess

Methods of valuation

• Assets based valuation method• Valuation Relative to industry average methods

– Dividend yield method– Return on capital employed– Earning yield method– Price earning method

• DCF valuation methods• Theoretical valuation models

Asset base valuation method

• All tangible and intangible assets are to be taken into account.• All fictitious assets are to be ignored• Present value of goodwill to be include in net asset. but value

given in b/s is to be ignored.• all outside liabilities to be taken on the value payable on the

date of valuation.• Any arrear of dividend, provision of tax and provision of

doubtful debt should be considered.• From the amount of the net asset the claim of the preference

share holder to be deducted to get the net amount of asset available to equity share holders.

Con..

• Asset base valuation method is good where the business is easily expressed in terms of its assets. EX Banks, mining companies etc.

• But this method is not good for companies where the primary assets are intangible assets like brand value and coy right etc.

• Major drawback in this method is that it does not value the items like skilled manpower, investment in marketing and research & development cost etc.

Value of share and company

• Value per share= market price of publically traded company

• Value of company=market price of equity share * no of equity share out standing

OR• Equity value + market value of debt+ minority

interest + pension provision+ other interests

Con.

• Intrinsic value of equity share= • net asset available to equity share holders

number of equity share

Dividend yield method

Value per share= company dividend per share Industry’s nominal rate per share

Value of business = value per equity share X total no of equity share

• Method is based upon the assumption that the dividend policy will remain constant, in practice companies can or do change their dividend policy.

• This methods gives different valuation for listed or unlisted companies because their dividend policies are different.

Earning yield method• To compare listed and unlisted companies

instead of dividend yield method earning yield method is used.

• Calculation of an earning yield value involve three step-– Predict the future maintainable profit (annual)– Identify the required earning yield with reference of

similar companies.– Value of business=

com. Exp. future maintainable profit Industries normal earning yield

Return on capital employed• Calculation of return on capital employed involve three

step-– Predict the future maintainable profit (annual)– Identify the acceptable normal rate of return on capital

invested with reference of similar companies.– Value of business=

com. Exp. future maintainable profit Industries normal rate of return on capital employed

Price earning method

• Value of company= com. Exp. future maintainable profit X Industry’s average P/E ratio

• Value of share= company’s expected earning per share X Industry’s average P/E ratio

Fair value

• Fair value of share = ( intrinsic value per share + value per share from earning yield method )/2

• Fair value of company = (value of company under asset based valuation method+ value of company from earning yield method )/2

Capitalization of Earnings• Capitalization of earnings focuses on the debt of the company that's being

merged or acquired. It's a measurement of the ratio between the company's capital structure and its debts =

• The company's long-term debt . • The shareholder's equity plus the company's long-term debt.• Long term debt includes things like bank loans and mortgages; it's what the

company uses to finance, or pay for, its operations.• Shareholder equity is the company's total assets minus total liabilities, that

is, the amount that the shareholders can claim after all debts and liabilities are paid.

• For valuation purposes, the ratio indicates how much debt the company uses to finance its assets.

• Generally, if the company has low debt and high equity, it's financially sound, and so its sale price will be higher than if it has high debt and low equity.

Tax Impact in M&A

Mergers & Acquisitions (M&A)

M&A recognized by Income Tax Act,1961 (ITA) Amalgamation/Merger Acquisition (transfer) of shares Demerger Sump sale/Itemized sale

TAX IMPLICATIONS IN MERGER/AMALGAMATIONS

Tax attracted in Amalgamations and Demergers

• Capital Gains Tax – Under the IT Act, gains arising out of the transfer of capital assets including shares are taxed. However, if the resultant company in the scheme of amalgamation or demerger is an Indian Company, then the company is exempted from paying capital gains tax on the Transfer of Capital Assets.

• Tax on transfer of Share – Transfer of Shares may attract Securities Transaction Tax and Stamp Duty. However, when the shares are in dematerialized form then no Stamp duty is attracted.

• Tax on transfer of Assets/Business – Transfer of property also attracts tax which is generally levied by the states. – Immovable Property – Transfer of Immovable Property attracts Stamp

Duty and Registration fee on the instrument of transfer. – Movable Property - The transfer of Movable Property attracts VAT

which is determined by the State and also Stamp Duty on the Instrument of transfer.

Transfer of tax Liabilities

– Income Tax – The predecessor is liable for all Income Tax payable till the effective date of restructuring. After the date of restructuring, the liability falls on the successor.

– Central Excise Act – Under the Central Excise Act, when a registered person transfers his business to another person, the successor should take a fresh registration and the predecessor should apply for deregistration. In case the predecessor has CENVAT Credit, the same could be transferred.

Con..

– Service Tax – As regards service tax, the successor is required to obtain fresh registration and the transferor is required to surrender his registration certificate in case it ceases to provide taxable services. The provisions regarding transferring the CENVAT credit are similar to the Central Excise provisions.

– Value Added Tax – Usually state government levy VAT and specify for an intimation of change of ownership and name to the relevant authority, but govt do not provide any specific guidelines with regard to the transfer of tax credit. The obligation of the predecessor and the successor is joint and several.

Definition and Chargeability

● Merger – not defined.● Amalgamation as per Section 2(1B) of ITA ● Under ITA, Capital gains are charged to tax u/s 45.● S. 45 – Profits & gains taxable when arising from

transfer of capital asset in India.● M&A Transactions are tax free only on merger of a

foreign or Indian company into an Indian company.

Exemption from CGT

● No CGT implications on mergers/amalgamations provided if they satisfy conditions of S. 47 of ITA.

● Conditions for exemptions from CGT - transfer of capital asset from amalgamating co.

to amalgamated co. is exempt if amalgamated co. is an Indian company. {S. 47(vi)}

transfer of share(s) in amalgamating co. is exempt if (i) transfer is for consideration of share(s) allotted to the shareholders of amalgamating co. in amalgamated co., and (ii) amalgamated co. is an Indian company. {S. 47 (vii)}

Contd…..

……Contd.

Exemption from CGT is applicable at shareholder level to the extent shareholders receive ‘shares’ as consideration.

Transfer of share(s) held in Indian co., by amalgamating foreign co. to amalgamated foreign co. is exempt if (i) at least 25% of shareholders of amalgamating foreign co. become the shareholders of amalgamated foreign co., and (ii) such transfer is not subject to capital gains tax in the home country of amalgamating foreign co. {S. 47 (via)}.

Treatment of accumulated losses & unabsorbed depreciation (S. 72A)

● Accumulated loss (AL) & Unabsorbed depreciation (UD) of amalgamating co. deemed to be AL & UD of amalgamated co.

● Entitlement is available if following conditions are fulfilled:

Amalgamating co. – has been in that business for at least 3 years, has held at least 3/4th of book value of fixed assets for 2

years.

Contd…..

……Contd.

Amalgamated co. – to continue the business (all businesses) of

amalgamating co. for at least 5 years, to hold least 3/4th of book value of fixed assets

of amalgamating co. for 5 years, to fulfill such other conditions as may be

prescribed to ensure the revival of business of amalgamating co. or that amalgamation is for genuine business purpose.

Other Tax Benefits

● Amalgamated co. can claim deduction for: Expenditure incurred on scientific research (S. 35) Expenditure for obtaining license to operate

telecommunications services (S. 35ABB) Preliminary expenses (S. 35D) Expenditure incurred for amalgamation (S. 35DD) Expenditure incurred under VRS(S. 35DDA) Expenditure on prospecting, etc., for certain minerals (S.

35E)

● Amalgamated co. is eligible for unexpired tax holidays under sections 10A, 10AA and 10B.

TAX IMPLICATIONS IN ACQUISITIONS

Modes of Acquisition & Classification of assets

● Acquisitions may generally take following forms: Acquisition of shares Acquisition of assets Acquisition of business (slump sale)

● Tax treatment and applicable rates under ITA depend upon type of acquisition and period of holding of a particular asset.

● “Long term capital asset” (LTCA) and “Short term capital asset” (STCA) are defined under S.2(29A) and S. 2(42A) of ITA.

● Gains arising from transfer of LTCA are “Long Term Capital Gain” (LTCG).

● Gains arising from transfer of STCA are “Short Term Capital Gain” (STCG).

Tax impact of Acquisition of shares

● Shares held for 12 months or less – Short term capital asset.

● Shares held for more than 12 months – Long term capital asset.

● Seller’s perspective : Chargeable under section 45 of ITA. STCG & LTCG rates depend upon whether shares are

listed or unlisted and also upon whether seller is resident or non-resident (refer to Tables on next slides)

DTAA (Mauritius) Article 13 – Capital gains derived by a resident of a State chargeable to tax in that State only.

● Buyer’s perspective: Section 195: Withholding tax Hon‘ble Supreme Court held in G.E. India Technology

Centre Private Ltd. Vs CIT & Anr. [MANU/SC/0688/2010] that “the payer is bound to deduct Tax at Source (TAS) only if the tax is assessable in India. If tax is not so assessable, there is no question of TAS being deducted”.

Vodafone acquisition of shares of Hutch raises a controversy over jurisdiction of IT Dept.- whether acquisition of shares by a non-resident entity from another non-resident entity is taxable in India in respect of capital gains of the non-resident seller and if so, does the non-resident buyer have a withholdings obligation u/s 195.

Issues arising from Vodafone transaction

● Jurisdiction over cross border transactions between non-residents.

● Extra territorial operation of Indian Laws.● Implications for overseas investors.● Possibility of other similar transactions to

come under tax scanner - Indemnity from the buyer.

Tax impact of Acquisition of assets

● Acquisition of assets may take place either as a purchase of one or more individual assets or as purchase of whole of the undertaking as a going concern (slump sale).

● Assets held for 36 months or less – Short term capital asset.

● Assets held for more than 36 months – Long term capital asset.

●

Tax impact of Slump Sale

● Slump Sale as per S. 2(42C) of ITA● The transaction of “Slump Sale” is

chargeable as capital gain under section 50B of ITA.

● Computation of capital gains in Slump Sale: If the capital asset being undertaking has been held

for more than 36 months – long term capital gain. If the capital asset being undertaking has been held

for 36 months or less – short term capital gain.

Slump Sale

Sale proceeds Net worth Capital gains

Value of liabilities Value of assets

WDV (depreciable assets)

(capital assets– deduction

allowable u/s 35AD)

Book Value (other assets)

itemized sale

• When an itemized sale of individual assets takes place, profit arising from the sale of each asset is taxed separately.

• Accordingly, income from the sale of assets in the form of “stock-in-trade” will be taxed as business income,.

• The sale of capital assets is taxable as capital gains. • Significantly, the tax rates on such capital gains would

depend on the period that each asset (and not the business as a whole) has been held by the seller entity prior to such sale.

TAX IMPLICATIONS IN DEMERGERS

Definition and Chargeability

● Demerger as per Section 2(19AA) of ITA All properties of undertaking before demerger

become properties of resulting co. All liabilities of undertaking before demerger become

liabilities of resulting co. Resulting co. issues shares in consideration. Shareholders (at least 3/4th in value) in demerged co.

become shareholder in resulting co. Transfer of undertaking is on a going concern basis.● Under ITA, Capital gains are charged to tax u/s 45.● Section 45 – Profits & gains taxable when arising

from transfer of capital asset in India

Exemption from CGT

● No CGT implications on demergers provided they satisfy conditions of S. 47 of the ITA.

● Conditions for exemptions from CGT – transfer of capital asset by demerged co. to

resulting co. is exempt if resulting co. is an Indian company. {S. 47 (vib)}

transfer or issue of share(s) by resulting co. to the shareholders of demerged co. is exempt if transfer or issue is in consideration of demerger. {S. 47 (vid)}

Contd…..

Contd…..Transfer of share(s) held in Indian co. by

demerged foreign co. to resulting foreign co. is exempt if (i) shareholders holding at least 3/4th in value continue to remain the shareholders of resulting foreign co., and (ii) such transfer is not subject to capital gain tax in the home country of demerged foreign co. {S. 47 (vic)}

Treatment of accumulated losses & unabsorbed depreciation (S. 72A)

● Resulting co. is allowed to carry forward and set off accumulated loss & unabsorbed depreciation of demerged co. in following manner: If loss/unabsorbed depreciation is directly

relatable to undertaking transferred to resulting co. – entirely allowed to be carried forward and set off.

If not directly relatable – then proportionately allowed to be carried forward and set off.

No such conditions like holding of at least 3/4th of book value of fixed assets for 2 years or continuance of business for a minimum specified period are applicable.

Other Tax Benefits

● Resulting co. is eligible to claim deduction for: Expenditure for obtaining license to operate

telecommunications services (S. 35ABB) Preliminary expenses (S. 35D) Expenditure incurred for demerger (S. 35DD) Expenditure incurred under VRS (S. 35DDA) Expenditure on prospecting, etc., for certain

minerals (S. 35E)

● Resulting co. is eligible for the unexpired tax holidays under sections 10A, 10AA and 10B.

Leveraged Buyouts

LBO• A leveraged buyout (LBO) is an acquisition of

a company or a segment of a company funded mostly with debt. A financial buyer (e.g. private equity fund) invests a small amount of equity (relative to the total purchase price) and uses leverage (debt or other non-equity sources of financing) to fund the remaining of the consideration paid to the seller.

LBO and MBO• Going private — transformation of a public

corporation into a privately held firm.• Management buyouts (MBOs)

– Investor group dominated by management– Segment acquired from parent company– The leveraged buyout performed mainly by

managers or executives of the company• Leverage buyout (LBO) — purchase of a

company by a small group of investors using a high percentage of debt financing– Investors are outside financial group or managers or

executives of company

Financial Buyers• In a leveraged buyout, all of the stock, or assets of a public

corporation are bought by a small group of investors (“financial buyers”), usually including members of existing management.

Financial buyers:• Focus on ROE rather than ROA. • Use other people’s money.• Succeed through improved operational performance.• Focus on targets having stable cash flow to meet debt service

requirements.– Typical targets are in mature industries (e.g., retailing,

textiles, food processing, apparel, and soft drinks)

Diagram of an LBO structure

• Buyout group may include management and may be associated with – Buyout specialists– Investment bankers or merchant bankers– Commercial bankers

LBO advantages and disadvantages

• Advantages include the following:– Management incentives,– Tax savings from interest expense and depreciation from asset write-

up,– More efficient decision processes under private ownership,– A potential improvement in operating performance, and– Serving as a takeover defense by eliminating public investors

• Disadvantages include the following:– High fixed costs of debt,– uncertainty because of business cycle fluctuations and competitor

actions,– Not appropriate for firms with high growth prospects or high business

risk, and– Potential difficulties in raising capital.

Classic LBO Models: Late 1970s and Early 1980s

• Debt normally 4 to 5 times equity. Debt amortized over no more than 10 years.

• Existing corporate management encouraged to participate.• Complex capital structure: As percent of total funds raised

– Senior debt (60%) – Subordinated debt (26%)– preferential share (9%)– Common equity (5%)

• Firm frequently taken public within seven years as tax benefits diminish

Role of Junk Bonds in Financing LBOs

• Junk bonds are non-rated debt. – Bond quality varies widely– Interest rates usually 3-5 percentage points above the prime rate

• Bridge or interim financing was obtained in LBO transactions to close the transaction quickly because of the extended period of time required to issue “junk” bonds.– These high yielding bonds represented permanent financing for the

LBO• Junk bond financing for LBOs dried up due to the following:

– A series of defaults of over-leveraged firms in the late 1980s – Insider trading and fraud at such companies a Drexel Burnham, the

primary market maker for junk bonds• Junk bond financing is highly cyclical, tapering off as the economy goes

into recession and fears of increasing default rates escalate

Break-Up LBO Model (Late 1980s)

• Same as classic LBO but debt serviced from operating cash flow and asset sales

• Changes in tax laws reduced popularity of this approach– Asset sales immediately upon closing of the

transaction no longer deemed tax-free– Previously could buy stock in a company and sell

the assets. Any gain on asset sales was offset by a mirrored reduction in the value of the stock.

Strategic LBO Model (1990s)

• Exit strategy is via IPO• D/E ratios lower so as not to depress EPS • Financial buyers provide the expertise to grow earnings

– Previously, their expertise focused on capital structure• Deals structured so that debt repayment not required until 10

years after the transaction to reduce pressure on immediate performance improvement

• Buyout firms often purchase a firm as a platform for leveraged buyouts of other firms in the same industry

Characteristics of recent LBOs

– Debt financing• Highly leveraged — up to 90% of purchase price• Debt secured by assets of acquired firm or based on

expected future cash flows• Paid off either from sale of assets or from future cash

flows generated by operations

– Acquired company became privately held– Firm expected to go public again after three to

five years

– Other target characteristics• Track record of capable management• Strong market position within industry to enable it

to withstand economic fluctuations and competition

• Highly liquid balance sheet– Little debt, either short or long term– Large unencumbered asset base — for collateral– High proportion of tangible assets with fair market value

above net book value

– Typical LBO operation• Financial buyer purchases company using high level of

debt financing• Financial buyer replaces top management• New management makes operating improvements• Financial buyer makes public offering of improved

company at higher price than originally purchased

• Conditions and circumstances of going-private buyouts. – Typical target industries

• Basic, non regulated industries– Predictable and/or low financing requirements– Predictable/stable earnings

• High-tech industry less appropriate– Shorter history of profitability– Greater business risk– Fewer leveragable assets– high P/E multiples well above book value

Factors Affecting Pre-Buyout Returns

• Premium paid to target firm shareholders consistently exceeds 40%

• These returns reflect the following (in descending order of importance):– Anticipated improvement in efficiency and tax benefits– Wealth transfer effects– Superior Knowledge– More efficient decision-making

Factors Determining Post-Buyout Returns

• Empirical studies show investors earn abnormal post-buyout returns

• Full effect of increased operating efficiency not reflected in the pre-LBO premium.

• Studies may be subject to “selection bias,” i.e., only LBOs that are successful are able to undertake secondary public offerings.

• Abnormal returns may also reflect the acquisition of many LBOs 3 years after taken public.

Valuing LBOs• A LBO can be evaluated from the perspective of common

equity investors or of all investors and lenders• LBOs make sense from viewpoint of investors and lenders if

present value of free cash flows to the firm is greater than or equal to the total investment consisting of debt and common and preferred equity

• However, a LBO can make sense to common equity investors but not to other investors and lenders. The market value of debt and preferred stock held before the transaction may decline due to a perceived reduction in the firm’s ability to– Repay such debt as the firm assumes substantial amounts

of new debt and– Pay interest and dividends on a timely basis.

• Stages of a typical LBO operation– First stage — raise cash required for buyout and

devise management incentive systems• Financing

– About 10% of cash is put up by investor group headed by company's top managers and/or buyout specialist

– About 50-60% of required cash through secured bank loans– Rest of cash by issuing senior and junior subordinated debt

» Private placement with pension funds, insurance companies, venture capital firms

» Public offerings of "high-yield" notes or bonds (junk bonds)

• Management incentives– Managers receive stock price-based incentive compensation

in form of stock options or warrants– Incentive compensation plans based on measures such as

operating performance

– Second stage — organizing how to takes company private

• Stock-purchase — buys all outstanding shares of company

• Asset-purchase — purchases all assets of company and forms new privately held corporation

• New owners sell off parts of acquired firm to reduce debt

– Third stage — management strives to increase profits and cash flows

• Cut operating costs • Cut spending in research and development• Cut new plants and equipment as long as provisions

for capital expenditures are adequate and satisfy lenders

• Increase revenues by changing marketing strategies

– Fourth stage — reverse LBOs• Investor group may take improved company public

again through public equity offering (secondary initial public offering - SIPO)

• Create liquidity for existing stockholders• Study on performance of LBO (1990)

– 72 reverse LBOs in 1976-1987– 86% of firms use offering proceeds to lower company's

leverage– Equity participants realized average annualized rate of return

of 268.4% on equity investment by time of SIPO– average length of time between LBO and SIPO was 29

months

– Leverage factors• Increase return on equity (ROE) and cash flows to

retire debt• Attractions for lenders

– Higher Interest rates above prime rate– Company and collateral characteristics

» Large amounts of cash/cash equivalents» Undervalued assets (hidden equity)» Could liquidate some subsidiaries to raise funds

– High prospective rates of return on equity especially for lenders such as venture capitalists and insurance companies with equity participation

– Confidence in management group spearheading LBO

– Management factors• Record of capability• Betting reputation and personal wealth on success

of LBO• Highly motivated by potential large personal gains

from stock ownership

• Sources of gains in LBOs– Tax benefits — can enhance already viable

transaction• Specific tax benefits

– Interest tax shelter from high leverage– Asset step-up provides higher asset value for depreciation

expenses; especially accelerated depreciation on assets involving little recapture — more difficult under.

– Tax advantages of using ESOP as LBO vehicle

Applications of the LBO Analysis

• Determine the maximum purchase price for a business that can be paid based on certain leverage (debt) levels and equity return parameters.

• Develop a view of the leverage and equity characteristics of a leveraged transaction at a given price.

• Calculate the minimum valuation for a company since, in the absence of strategic buyers, an LBO firm should be a willing buyer at a price that delivers an expected equity return that meets the firm's hurdle rate.

Things to Remember…

• LBOs make the most sense for firms having stable cash flows, significant amounts of unencumbered tangible assets, and strong management teams.

• Successful LBOs rely heavily on management incentives to improve operating performance and a streamlined decision-making process resulting from taking the firm private.

• Tax savings from interest expense and depreciation from writing up assets enable LBO investors to offer targets substantial premiums over current market value.

• Excessive leverage and the resultant higher level of fixed expenses makes LBOs vulnerable to business cycle fluctuations and aggressive competitor actions.

• For an LBO to make sense, the PV of cash flows to equity holders must equal or exceed the value of the initial equity investment in the transaction, including transaction-related costs.

Due diligence

• A process whereby an individual, or an organization, seeks sufficient information about a business entity to reach an informed judgment as to its value for a specific purpose.

Due diligence for M&A• A future-oriented super audit to help minimize the risk

and maximize the shareholder value of an M&A transaction.

• The examination of a potential target for merger, acquisition, privatization or similar corporate finance transaction normally by a buyer.

• a reasonable investigation focusing on material future matters.

• an examination being achieved by asking certain key questions, including, do we buy, how do we structure the acquisition and how much do we pay?

• an examination aiming to make an acquisition decision via the principles of valuation and shareholder value analysis.

Basic due diligence • Bidder wants to determine the following basic information about the target

company:• Its capital structure including shareholding pattern. • The composition of its board of directors. • Any shareholders’ agreement or restrictions on the shares, for example, on

voting rights or the right to transfer the shares. • Its level of indebtedness. • Whether any of its assets have been offered as security for raising any debt. • Any significant contracts executed by it. • The status of any statutory approvals, consents or filings with statutory

authorities. • Employee details. • Significant litigation, show cause notices and so on relating to the target

and/or its areas of business. • Any other liability, existing or potential.

The due diligence process • can be divided into nine distinct areas:• Compatibility audit.• Financial audit.• Macro-environment audit.• Legal/environmental audit.• Marketing audit.• Production audit.• Management audit.• Information systems audit.• Reconciliation audit• shareholder value analysis

Con..• The Compatibility Audit which deals with the strategic

components of the transaction and in particular the need to add shareholder value.

• The management audit is Analysis and assessment of competencies and capabilities of a company's management in order to evaluate their effectiveness, especially with regard to the strategic objectives and policies of the business. The objective of a management audit is not to appraise individual executive performance, but to evaluate the management team in relation to their competition.

The Macro-environmental • component examines six main areas

• Demographics• What major demographic developments and trends opportunities or threats to

the company? What is action plan?• Economic• What major developments in income, prices, savings and credit will affect the

company ? action plan?• Environmental• What is the outlook for the costs and availability of natural resources and energy

needed by the company? Plan?• Technology• What major changes are occurring in product and process technology?• What is the company's position in these technologies?• Political- what will be the impact of political change on your company Cultural• Customer-What is the public's attitude towards business and toward the

company's products?• What changes in customer lifestyles and values might affect the company?

Marketing audit

• How is marketing team organised?• How efficient is marketing team?• How effective is marketing team?• How effective are they at Customer Relationship

Management (CRM)?• What is the state of marketing planning process?• Is marketing planning information current and accurate?• What is the current state of New Product Development?

(Product)• How profitable is product portfolio?

• Information system audit - Information Systems is the heart of an organization. Its success is dependent on its methodologies and its process framework. Teamed up with the right infrastructure, companies who have properly planned information systems in place are the ones who gain maximum competitive advantage. So There is a need to evaluate the actual properties of an information system .

• The Reconciliation audit, which links/consolidates other audit areas together via a formal valuation in order to test whether shareholder value will be added.

• In business transactions, the due diligence process varies for different types of companies. The relevant areas of concern may include the financial, legal, labor, tax, IT, environment and market/commercial situation of the company. Other areas include intellectual property, real and personal property, insurance and liability coverage, debt instrument review, employee benefits and labor matters, immigration, and international transactions.

Why Perform Due Diligence• Is there a law that mandates due diligence examinations in

certain circumstances?• Directors has some fiduciary duties. One such basic fiduciary

duty is the duty of care. • It is clear from a number of court decisions that a buyer’s board

of directors would be in breach of its fiduciary duty of care if it did not perform due diligence on a target company prior to acquisition, or did not perform an adequate due diligence examination.

• These cases also make clear, however, that boards are free to delegate the due diligence examination, and thereby discharge their fiduciary duty in this respect, to outside professionals, such as accountants, investment bankers, lawyers, and other experts.

IP due diligence in Mergers & Acquisitions

• IP Due diligence is the process of investigating a party’s ownership, right to use, and right to stop others from using the IP rights involved in sale or merger .

• The nature of transaction and the rights being acquired will determine the extent and focus of the due diligence review.

Due-diligence of IP should reveal

• Who owns the rights? Are the rights valid and transferable and enforceable?

• Are there any agreement or restriction that prevent the party for granting rights to other?

• Is the property registered in the proper office?• Any shortcoming or default on payment?• Any past or potential litigation• Has the property being misused in the past?• Any encumbrances?• It should also evaluate agreements material to the

company’s business that may be affected by change of control, agreements that may vest rights in intangibles, and company policies and practices

Importance of Intellectual Property due diligence

• The increased profile, frequency, and value of intellectual property related transactions have elevated the need for all legal and financial professionals and IP owner to have thorough understanding of the assessment and the valuation of these assets, and their role in commercial transaction

• Intellectual Property due diligence generally provides vital information specific to future benefits, economic life and ownership rights and the limitations of the assets all of which affects final value.

• Therefore due diligence is prerequisite to the valuation process, regardless of the methodology used.

AMALGAMATION, MERGER, ACQUISITION & TAKEOVER

AMALGAMATION "blending together of two or more undertakings into one undertaking, the shareholders of each blending company, becoming, substantially, the shareholders of the blended undertakings. There may be amalgamations, either by transfer of two or more undertakings to a new company, or to the transfer of one or more companies to an existing company”.

Amalgamation & Mergers

X Y+Example = Z

X Y+ = X

"MERGER" its an arrangement, whereby the assets of two companies become vested in, or under the control of, one company (which may or may not be one of the original two companies), which has as its shareholders all, or substantially all, the shareholders of the two companies.

Amalgamation & Mergers

Procedure for Amalgamation / Merger

Check MoA (change accordingly).Draft Scheme of Arrangement ( Amalgamation / Merger).Consider it in Board Meeting.Apply to Court direction to call General Meeting.Sent copy of application made to High Court to Central Gov.Send notices of General Meeting to with schemeNotice Period shall not be less than 21 days Notice can be way of Advertisement alsoAt General Meeting approve scheme, increase authorized share capital and to issue further shares, as required

Procedure for Amalgamation / Merger

Forward promptly notice and proceedings of meeting to SE’s

Report the result of the meeting to Court

Move Court for approval of the scheme by filing petition in 7 days in Form 40

Advertise the date of hearing fixed by the court

On receipt of Order from High Court, file it with RoC.

Proceed on effecting the scheme amalgamation / merger as approved by High Court

Section 391 – 394 of the Companies Act, 1956 deals with Compromises, Arrangements and Reconstructions and other related issues through schemes of arrangement approved by the High Courts. A resolution to approve the scheme of arrangement has to be passed by the shareholders in the general meetings. The shareholders have to vote on the resolutions on the schemes of arrangement on the basis of the disclosures in the notice/explanatory statement. Section 393 of the Companies Act, 1956 specifies the broad parameters of the disclosures which should be given to the shareholders / creditors, for approving a scheme of arrangement.

Amalgamation & Mergers

Amendment in the Companies Act, 1956 in year 2002 gave powers to National Company Law Tribunal to review and to allow any compromise or arrangement, which is proposed between a company and its creditors or any class of them or between a company and its members or any class of them. However, because of non formation of National Company Law Tribunal, these powers still lie with High Courts and the parties concerned can make applications to high courts.

If the Creditors, Members present at a General meeting representing three fourth of total number agree to any compromise or arrangement, it becomes binding on the rest of the members or creditors provided the tribunal sanctions the compromise or arrangement.

The order made by Tribunal will come in to effect only after the filing of certified copy with the Registrar of Companies.

Section 391

Section 391

Court’s power under the section are very wide and has discretion to allow any sort of arrangement between the company and members.

Scope and ambit of the Jurisdiction of the Court:

The sanctioning court has to see to it that all the requisite statutory procedure for supporting any scheme has been complied with along with requisite meetings.

That the scheme put up for sanction of the court is backed up by the requisite majority vote.

That the concerned meetings of the creditors or members or any class of them had the relevant material to enable the voters to arrive at an informed decision for approving the scheme.

That the proposed scheme is not found to be violative of any provision of law and is not contrary to public policy.

Under this section, the court has power to supervise the carrying out of the compromise or an arrangement; and

may, at the time of making such order or at any time thereafter, give such directions in regard to any matter or make such modifications in the compromise or arrangement as it may consider necessary for the proper working of the arrangement.

If the court is of the view that a compromise /arrangement sanctioned under section 391 cannot be worked satisfactorily with or without modifications, it may on it own motion or on the basis of an application made by an interested party may order winding up of the company under section 433 of the Act.

Section 392

Section 393This section prescribes the procedure required for convening the meeting of the members or creditors called under section 391.

The notice for the meeting should be sent along with a statement setting forth the terms of the compromise and or arrangement and explaining its effect and in particular, the statement must state all material interest of the directors, managing directors of the company, whether in their capacity as such or as members or creditors of the company or otherwise.

Where the compromise or arrangement affects the rights of debenture holders of the company, the statement shall give the information and explanation in respects to the trustees of any deed for securing the issue of the debentures as it is required to give in respect of directors.

Any default in complying with the requirements under this section may lead to a fine of Rs. 50, 000 against the concerned official of the company, who is found guilty.

Section 394 Where the court is of the view that the proposed

arrangement/scheme is of such nature that • the scheme is for the reconstruction of any company or for

amalgamation of any two or more companies; and • that under the scheme the whole or any part of the undertaking

property or liabilities of any concerned company is to be transferred to another company;

the court may make provision for all or any of the following matters. The transfer to Transferee Company of the property or liabilities of

transferor company. The allotment or appropriation by the transferee company of

any shares, debentures or other like interest in that company which, under the arrangement, are to be allotted or appropriated by that company to.

The continuation of any legal proceeding against the transferee company by the transferor company.

The dissolution, without winding up, of any transferor company.

The provisions for any dissenting persons. Who are opposing such scheme or any other matter, which the court deems fit.

Major Laws Involved

SEBI (substantial Acquisition of shares &Takeovers) Regulations 1997.

The Securities and Exchange Board of India Act,1992 .Security Contract Regulation Act ,1956 .The Depositories Act,1956.SEBI Disclosure and Investor Protection Guidelines 2000.Securities and Exchange Board of India (Prohibition of Insider

Trading Regulation ),1992.Securities and Exchange Board of India (Merchant Bankers)

Rules/Regulation 1992.SEBI (Delisting of Securities )Guidelines,2003.Foreign Exchange Management Act,1999.Companies Act,1956.

Acquisitions & Takeovers

PROCEDURE (SAST,1997)

Reg-7:Disclosuure to company and to stock exchange by any person who acquire more than 5%,10% or 14% shares

Reg-10: NO acquirer shall acquire 15% or more shares unless such acquirer makes a public announcement to acquire shares of such company as per SAST,1997.

Acquisitions & Takeovers

PROCEDURE (SAST,1997)…….continued

Reg-11: If (15%-75%) shares acquired as per Law then no acquirer can acquire additional shares which entitle him to exercise 5% or more in any financial year, unless public announcement is made.

Acquisition :-* Direct Acquisition in a listed company to which the

Regulation apply.* Indirect acquisition by virtue of acquisition of companies,

whether listed or unlisted, whether in India or aboard.

Acquisitions & Takeovers

PROCEDURE (SAST,1997)…….continued

Reg-13:Before making public announcement merchant banker is to be appointed

Reg-14:Timing of Public Announcement Offer not later than 4 working days after agreement for acquisition of shares.

Reg-15: Public Announcement of offer to be made in newspaper, Hindi, regional and mostly traded area. Public Announcement shall be submitted to: SEBI through merchant Banker

Acquisitions & Takeovers

PROCEDURE (SAST,1997)…….continued

Reg-18:Within 14 days from the date of Public Announcement draft letter of offer to be filed with SEBI through Merchant Banker.

The letter of Offer to be dispatched to share-holders not earlier than 21days.

Reg-19: Public announcement shall specify a date for the purpose of determining the name of the shareholder to whom Letter of Offer will be sent shall not be later than 30th day.

Acquisitions & Takeovers

PROCEDURE (SAST,1997)…….continued

Reg-21: Minimum number of shares to be acquired by Public offer-20%.

If the public shareholding goes below 10%, delisting of securities guidelines will apply.

Reg-28: ESCROW- The acquirer by way of security performance of his obligation, deposit in ESCROW account sum as under

For consideration (C) payable under the public offer upto and including C=<100 cr - 25%

C>100 cr - 25% upto Rs.100 cr &10% thereafter.

Acquisitions & Takeovers

PROCEDURE (SAST,1997)…….continued

Reg-29: PAYMENT OF CONSIDERATION 7days from closure of offer open special account

with Banker to an issue and deposit sum as would together with 90% of lying in ESCROW make up entire sum due and payable to shareholders.

Acquisitions & Takeovers

Discounted cash flow models

Dividend discount models

DIVIDEND DISCOUNT MODEL

• CONSTANT GROWTH DIVIDEND DISCOUNT MODEL

• V0= VALUE OF EQUITY• D= DIVIDEND PAID IN NEXT YEAR• Ke= COST OF EQUITY OF THE COMPANY• G= GROWTH RATE FOREVER

GKe

DV

10

the present value of DIVIDEND FOR EXPLICITE PERIOD and terminal value

• This will give the value of firm= PV of the cash flows during the high growth(explicit period) + PV of terminal value.

• Value of the firm = +

• Value of the security per share = value of the equity/ number of equity share

)(1

1)(

)1((

Ke

N

N

GKe

GD

N

NNKe

DN

1)1(

FREE CASH FLOW TO FIRM MODEL

• CONSTANT GROWTH FCFF MODEL

• V0= VALUE OF FIRM• FCFF1= EXPECTED FCFF NEXT YEAR• WACC= WIGHTED AVERAGE COST OF CAPITAL• G= GROWTH RATE FOREVER

GWACC

FCFFV

10

Step I : Estimate free cash flows available • to all the suppliers of the capital viz. equity holders,

preference investors and the providers of debt.• Free Cash Flow = EBIT (1- T) + Depreciation – CAPEX - Δ

NWC ,where:• EBIT is earnings before interest and taxes.• T is the marginal tax rate.• Depreciation is noncash operating charges including

depreciation, depletion, and Amortization recognized for tax purposes.

• CAPEX is capital expenditures for fixed assets.• ΔNWC is the change in net working capital.

Step II : Estimate a suitable Discount Rate • which is normally represented by weighted average of

the costs of all sources of capital, which are based on the market value of each of the components of the capital.

• WACC = Wd*kd*(1-T) + We*ke , where:• kd is the interest rate on new debt.• ke is the cost of equity capital (see below).• Wd, We are target percentages of debt and equity (using

market values of debt and equity.)• T is the marginal tax rate.

• Step III : Cash flows computed in Step I are discounted at the rate arrived at in Step II.

N

NNWACC

FCFFV

N

1

0)1(

Step IV : Estimate the Terminal Value of the business

• Which is the present value of cash flows occurring after the forecast period.

• where, FCFF is the cash flow in last year of forecast period.

• G is constant growth rate and• WACC is the discount rate.

GWACC

GFCFFTV

N

)1(

N

Calculation of growth rate

• Expected growth rate =• Average Reinvestment rate X Return on capital

• Reinvestment rate=(Net Capex + change in NWC)

• EDIT(1-t)• Net Capex = Capex - depreciation

• Reurn on capital = WACC

Step V: Add the present value of free cash flows and terminal value

• This will give the value of firm= PV of the cash flows during the high growth + PV of terminal value.

• Value of the firm = +

• Value of the equity= value of the firm + cash and marketable securities – debt

• Value of the security per share = value of the equity/ number of equity share

)(1

1)(

)1((

WACCGWACC

GFCFFN

N

N

NNWACC

FCFFN

1 )1(

FREE CASH FLOW TO EQUITY MODEL

step I:estimate FCFE

• Free cash flow to equity = net income* equity reinvestment rate

• FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment

FREE CASH FLOW TO EQUITY MODEL

• CONSTANT GROWTH FCCE MODEL

• V0= VALUE OF EQUITY• FCFE1= EXPECTED FCFE NEXT YEAR• Ke= COST OF EQUITY OF THE COMPANY• G= GROWTH RATE FOREVER

GKe

FCFEV

10

Calculation of growth rate

• Expected growth rate =• Average Reinvestment rate X non cash ROE

• Reinvestment rate=(Net Capex + NWC- net debt)

• non cash net income• Net Capex = Capex - depreciation

• Non cash ROE = Non cash net income• (book value of equity-cash)

Step II: Discount rate

• cost of equity is discounted rate i.e. Ke

Step III

• Step III : Cash flows computed in Step I are discounted at the rate arrived at in Step II.

N

NNKe

FCFEV

N

1

0)1(

Step IV : Estimate the Terminal Value of the business

• Which is the present value of cash flows occurring after the forecast period.

• where, FCFE is the cash flow in last year of forecast period.

• G is constant growth rate and• Ke is the discount rate.

GKe

GFCFETV

N

)1(

N

Step V: Add the present value of free cash flows and terminal value

• This will give the value of firm= PV of the cash flows during the high growth + PV of terminal value.

• Value of the firm = +

• Value of the equity= value of the company + cash and marketable securities

• Value of the security per share = value of the equity/ number of equity share

)(1

1)(

)1((

KeN

N

GKe

GFCFE

N

NNKe

FCFEN

1)1(