M&A Introduction

Level 1 Module 1 Session 1

IFAP

Reshma Krishnan

Why are you here?

• To understand what an Analyst does in the context of Corporatefinance and Investment Banking

• To acquire skills critical to being a good analyst

• To go beyond corporate finance theory

Logistics

• Programme Manager & M&A track faculty- Reshma Krishnan

– Email: re.krishnan@gmail.com

• Programme Administrator & soft skill faculty – PradeepKhanapure

– Pradeep.khanapure@imarticus.org

• Faculty- Harish Menon

• Faculty – Hemal Lotia

• Walk-in hours – Saturday 9-10 (Before Class) on notified days

Financial Analysis Landscape

INVESTMENT BANKING

• Capital Raising

• Debt

• Equity

• Advisory Services

• M&A

• Restructuring

EQUITY & CREDIT

RESEARCH

PROJECT FINANCE

CONSULTING

• Corporate Finance Advisory

• Forensic and Dispute Services

• M & A Transaction Services

• ReorganisationServices

• Project Structuring

• Portfolio Monitoring and Collections

• Risk Analysis

• Debt, Sub-debt, Quasi-Equity Funding, Equity Investments

• Analysis of stock markets worldwide

• Economic, Strategy and Commodities Research Analysis

• Corporate Debt

FINANCIAL ANALYSIS

Two guiding Principles

How do I become bigger?

Increase my sales faster and in a sustained manner?

How do I make more money? Increase my profitability in a faster and

Top Line

Bottom Line

Financing

IPO

DebtProject Finance

Private Equity

Vehicles of Growth

Organic-Greenfield• Time• Resources

InorganicM&A• Options• Market• Price

Equity Capital Markets

Analyst Buy-sideSell-side

Hedge FundsMutual FundsInsurance Companies HNIWealth Management

Brokerage FirmsIPO Equity Research Analysts

Make or Buy?

Why should you buy? - Strategic Rationale For M&A

Start-up Growth

Maturity Transformation

TIME

REVENUE

Start-up

• Acquire established market access and track record

• Acquire a platform for growth

Growth

• Fill strategic gaps

• Geographic expansion

• Bulk-up of revenues and client base

• Capability augmentation

• Land grab

Maturity

• Market share consolidation

• Introduction of new business lines

• Block & Tackle

Transformation

• Acquire a platform in order to reorient business model around that

What is M&A and how does it create value?

• 1+1=3

• The key principle behind buying a company is to create shareholdervalue over and above that of the sum of the two companies. Twocompanies together are more valuable than two separatecompanies - at least, that's the reasoning behind M&A.

M&A is not one word

• Mergers- Merger of equals. A merger happens when two firms, oftenof about the same size, agree to go forward as a single new companyrather than remain separately owned and operated.

– Rare

– Exchange of Stock

– Daimler- Benz & Chrysler merged to become Daimler Chrysler

• Acquisition-When one company takes over another and clearlyestablished itself as the new owner, the purchase is called anacquisition

– More often the case

– Will buy the entire stock of the company

– Tata buying Jaguar

The concept of ‘Synergy’- the Holy Grail of M&A

• The magic behind the M&A; the holy grail

– Staff Reductions

– Competition elimination

– Economies of Scale

– Acquiring new technology

– Improved Market Reach and Industry Visibility

Types of M&A

Mergers

HorizontalTwo companies that are

in direct competition and share the same product

lines and markets.

Vertical

A customer and company or a supplier and

company. Think of a cone supplier merging with an

ice cream maker.

Conglomerate A garment manufacturer buying a confectionary

Understanding the value chain of an industry

Rough Production and mining

Preparing Rough and reselling

Value Add: Sorting roughs as per colour, clarity

and size

Cutting and Polishing

Value Add:Sizing the

diamond into shapes that maximise

yield and refraction of light

JewelleryManufacturing

Value Add:Setting

Cut & Polisheddiamonds

into jewellery

Retail Sales of Diamond Jewellery

Brokers & Distributors

Distributors

Distributors

Glitter’s presence across the value chain allows it to bypass the costs of middle men and also control quality of raw material at each stage thereby leading to higher margins.

Diamond company expertise across the value chain

Changing Industry structure: The disappearance of middle man is advantageous to players such as Glitter who do not depend on them for raw

materials and now have the opportunity to cater to major customers like jewellery manufacturers and retailers on their own leading to a significant

expansion in margins.

Inorganic Growth Opportunities: Glitter can focus its inorganic growth efforts across the value chain enabling it to spur its growth exponentially over

the coming years as the fragmented industry starts to consolidate.

Valuation in M&A- How much will you pay?

• DCF determines a company's current value according to its estimated future cash flows. Forecasted free cash flows (operating profit + depreciation + amortization of goodwill – capital expenditures –cash taxes - change in working capital) are discounted to a present value using the company's weighted average costs of capital (WACC).

•What have similar transactions been valued at in terms of P/E and Revenue Multiples

• Make or buy• Price to Earning Ratio: Multiple of Earnings of company

• Enterprise Value to Sales Ratio-Multiple of revenues versus Industry

Comparative Ratios/Comp

arables

Replacement Cost

Discounted Cash Flow

(DCF)

Transaction Comparables

Control Premium

• For the most part, acquiring companies nearly always pay a substantial premium on the stock market value of the companies they buy. The justification for doing so nearly always boils down to the notion of synergy; a merger benefits shareholders when a company's post-merger share price increases by the value of potential synergy.

• Pre Merger value of both firms +Synergy = Pre Merger Stock Price Post Merger Number of Shares

Indian M&A Market –An Overview

M&A in India has grown at a significant rate between 2003 and 2007 at a

CAGR of almost 58% with focus being on IT & ITES, Telecom, Energy &

Life sciences sectors. A majority of the M&A transactions had been cross-

border in nature.

Source: Grant Thornton

Indian M&A Market• Domestic• Cross border

• Inbound- No mega deals• Outbound- Decline in the

last few years because of the Global Crisis.

Global M&A• Down 2% to 2.78 Trillion• Oil & Gas Led the Global

Sector• 42,455 deals• The $54.5bn pending bid for

TNK-BP by Rosneftegaz, announced on 22nd October, was the largest deal of the year and accounted for 14% of total Oil & Gas volume

M&A Pitfalls- why over half of them fail to create any value…

• Overestimate Savings and imagine

the synergies don’t exist.

• Underestimate integration and

deal costs.

February 20, 2007, Bear Sterns ordered

by a U. S. Bankruptcy Judge in New York

to repay $159 million to the Trustee of

Manhattan Investment Fund Ltd. for

providing services to the fund from 1996

to 2000 provides a stark example of the

huge risk-to-reward gulf if your

company’s due diligence procedures are

not what they should be.

The 2002 merger of HP and Compaq is a

good example of culture clash. Significant

differences were: Compaq tended was

market-oriented and aggressive, while the

traditional HP emphasized teamwork,

consensus and long-term view. Consulting

firms helped HP conduct 144 focus groups

and 150 interviews in 22 countries. These

firms discovered that the situation was

ready-made for massive culture clash.

Evaluation Diligence Implementation

• Cultural Clash: Companies are

like people and have their own

personalities. Merging two

extremely different cultures

often results in a failed merger.

• Inadequate Due Diligence: This often

happens in the auction process when speed

is of the essence and buyers are expected to

finish due diligence quickly to ensure

Closure of transaction.

Merger of AOL-Time Warner’s

synergies ascribed to the deal were

over sold. The shareholders of AOL

owned 55% of the new company

while Time Warner shareholders

owned only 45%, wall street worry

was that the smaller AOL had in

fact bought out the far larger Time

Warner.

Deal Heat/ winners Curse: Bidders get caught up in a deal and lose sight of value and strategic fit and focus on winning thereby losing synergies.

Tata Corus- An analysis of why this time is different

• Corus, the merger between British Steel and Hoogovens in 1999, underestimated the integration valuing the

companies market cap at US$ 6 billion, but in 2005 the company was worth US$ 250 million.

Corus was an attempt to revive the ailing British Steel which had incurred a net loss of £81 million in the

March 1999.

Corus’s Failure:

Chief among them being the cultural mismatch between the merged entities and the lack of HR involvement

when integrating the two entities.

Large scale labour unrest due to the downsizing and rationalization of various operations seriously impacted

the normal functioning of the new organization.

The high valuation of the British pound and stagnation in demand for steel was gradually undermining the

competitiveness of British Steel in the European market.

CORUS FAILURE

Wishful Thinking!

Wishful Thinking!

Tata Corus- An analysis of why this time is different

TATA CORUS DEAL Tata Steel acquired Britain’s Corus for £5.75 billion ($11.3 billion now 12.1) in 2007.

Tata-Corus combine will become the fifth largest steelmaker in the world.

The New TATA-Corus

Access to low-cost slabs:

The ability to export surplus slabs either from Tata Steel's facilities or through acquisitions in low-

cost regions over the next few years will be the key driver of this deal.

Restructuring of Corus' existing units:

It is likely that over the next few years, Tata Steel will put through an extensive restructuring of its

underperforming units at Port Talbot and Scunthorpe in the UK, though it has ruled out any job

cuts. It may also prune down high-cost slab facility at Teesside.

Better Implementation and management of Cultural issues:

The ruling out of job cuts creates a better environment post integration unlike the one seen in the

earlier transaction.

Quantified Potential synergies:

For the first time since this deal surfaced, Tata Steel has quantified that it will benefit to the tune

of $300-350 million every year. However, the benefits from the deal may be lower than this

amount spelt out in the first two years and attain this level from the third year onwards.

Winners Curse!

• A tendency for the winning bid in an auction to exceed the intrinsic value of the item purchased.

• Tata Corus had quantified synergies but many reckon that they might have bid almost

– The acquisition by Tata amounted to a total of 608 pence per ordinary share or ₤6.2 billion (US $12 billion) which was paid in cash. First of all, the general assumption is that the acquisition was not cheap for Tata. The price that they paid represents a very high 49% premium over the closing mid market share price of Corus on 4 October, 2006 and a premium of over 68% over the average closing market share price over the twelve month period. Moreover, since the deal was paid for in cash automatically makes it more expensive, implying a cash outflow from Tata Steel in the amount of £1.84 billion.

Thank you

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