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DO NOT DISTRIBUTE

Faculty: Alok Katre (CA, CFA)

alok.katre.vf@scmhrd.edu

Alok Katre 02/01/2024 3

FORMS OF BUSINESS COMBINATIONS
 M&A is a generic term for the combining any two businesses, but can be done in various ways

 Merger: represents the absorption of one company by another. That is, one of the companies
remains and the other ceases to exist as a separate entity.
 Consolidation: both companies terminate their previous legal existence and become part of a
newly formed company
 Acquisition: refers to the purchase of part or whole of one company by another. The company
being acquired ceases to exist after the deal
 The company being acquired is called the “target” and the one acquiring the “acquirer”

 Depending on the relation of the acquirer and target, a M&A deal can be classified as:
 Horizontal merger: mostly a deal between two competitors (e.g. Vodafone & Idea). Most common type.
 Vertical merger: acquisition in the same production chain. Acquisition of a supplier is called “backward
integration” and customer “forward integration”. (E.g. Adani’s acquisition of Carmichael mine in Australia)
 Conglomerate merger: M&A deal in a totally unrelated line of business (e.g. RILs acquisition of Infotel
Broadband in 2010 to foray into telecom)

Alok Katre 02/01/2024 4

M&A DEALS – TRANSACTION CHARACTERISTICS…
 Form of acquisition: stock purchase or asset purchase…
Stock purchase Asset Purchase
Target shareholders receive Payment made to the selling company
Payment compensation in exchange for their shares rather than directly to the shareholders
Shareholder approval May not be
required, unless asset is key or sizeable
Approval Shareholder approval required part of seller
Tax: Corporate No corporate-level taxes Capital gains tax for target company
Tax: Shareholder Capital gains tax for shareholders of target No tax implications for target.
Liabilities Acquirer assumes liabilities of target Usually avoided by acquirer

 Method of payment:
 Cash payment: simplest and cleanest for of paying for an acquisition.
 Share based payment: target’s shareholders / target receive shares. ‘Exchange ratio’ based on
‘undisturbed price’ of acquirer’s and target’s shares before the deal
 Mixed offering: a combination of cash and shares/securities. Increases the complexity of deal valuation…

 Mindset of target management: Can be “hostile”, “friendly”, “negotiated”, “defensive”,

“forced” or “going private”
 Takeovers can start via small stakes bought in the target, but are then usually followed by “tender offers”
 Depending on the deal type, the process going into and exiting the deal varies

Alok Katre 02/01/2024 5

MOTIVES FOR MERGERS…
Key Motives for M&A deals

Strengthening Unique products/

Synergies Growth Diversification
mkt position skills
 Revenue  Common when  Increasing  Common when  Spreading the
synergies: e.g. industry is market share developing the risks across
cross-selling, mature and and influence skills in-house multiple end
geographical organic with suppliers is expensive or markets
reach, >share growth is low. and distributors not feasible.. (unrelated
of customer’s  Acquisition to gain “pricing  E.g. acquisition areas)
wallet accelerates power” by of a new  Deploying cash
 Cost growth or reducing technology, to diversify
synergies: company can competition process know- into areas of
scale benefits, acquire a faster (VODA-IDEA) how, R&D skills growth (e.g.
eliminating growing firm in  Defensive or distribution RIL’s foray into
overlaps a different purpose if there network.. telecom)
(factory, R&D, region or an is a 800lb  E.g. in Pharma  Geographical
admin, etc), ancillary area of gorilla in the or Biotech diversification
 Stock markets business room!! space, R&D of sales and
treat revenue  E.g.: Walmart- (SIE/ALO deal) pipelines are cost bases and
synergies with Flipkart  Offensive if valuable gaining access
sceptism market is to growing
fragmented markets

Deals can end up having multiple motives, but there is always a primary/key reason from the above…

Alok Katre 02/01/2024 6

 M&A ACCOUNTING…
 Largely via purchase accounting method where balance sheet of the target adjusted to fair value;

 Difference between net worth of target and value paid is recorded as “Goodwill” or “Capital Reserve”
Company A Company B
Capital + Reserves 4,652 36,176
Borrowings 3,623 8,351
Other Liabilities 2,205 19,583
Total Liabilities 10,480 64,110
Fixed Assets 221 5,528
Investments 3,963 17,965 Assume Firm B acquires firm A
Other Assets 5.621 37,793 by paying 25% premium over the
Cash & Equivalents 675 2.824 market price
Total Assets 10,480 64,110 Prepare accounts assuming this
Sales 2,322 9,926 is:
Expenses 2,080 5.960
1. All cash deal
2. Share-swap
Operating Profit 241 3.966
Cost of funds for firm B is 10%
Other Income 496 506
Interest 226 2,680
Depreciation 17 766
Profit before tax 495 1,026
Tax % 35.6% 70%
Net Profit 319 306
# of shares (cr) 23 178
Share price (Rs.) 1,000 250

Alok Katre 02/01/2024 7

M&A ACCOUNTING – MAIN CALCULATIONS REQUIRED
Goodwill calculation Rs. Cr Swap ratio for all share deal
Value offered to Co. A Firm A share price 1,000
Current Share price of A (Rs) 1,000 Premium 25%
Premium paid over share price 25% Price paid per share of Co. A 1,250
Price paid/offered (Rs.) 1,250
Co. B’s share price 250
# of shares of Co. A 23
Swap ratio* (= 1250 / 250) 5:1
Total Consideration (to shareholders of Firm
A = Price x No. of shares) 28,750 (Swap ratio = No. of shares of B given for
Net Assets of Co. A acquired (= Assets each share of A)
acquired – debt – other liabilities) 4,652
# of shares of A 23
Goodwill (Consideration paid – Net Assets
acquired) 24,098 # of shares of B issued to A (= 5 x 23) 115
Value of shares issued (=115 x 250) 28,750
Source of Funds for cash deal Rs. Cr
Investments 17,965
Cash 2,824
Debt 7,961
Total 28,750

Alok Katre 02/01/2024 8

 Value of shares
M&A ACCOUNTING – COMBINING THE FINANCIALS issued to A (=
consideration)
Assets / Firm B + Combined Payments Combined
Liabilities A/L from Share statements - cash statements
Co. A Co. B acquired Firm A swap (share deal) deal Goodwill (cash deal)
Capital + Reserves 4,652 36,176 36,176 28,750 64,926 36,176
Borrowings 3,623 8,351 3,623 11,974 0 11974 7,961 19,935
Other Liabilities 2,205 19,583 2,205 21,788 0 21788 21,788 Adjustment for
Total Liabilities 10,480 64,110 5,828 69,938 28,750 98,688 7,961 0 77,899 payment to A
Fixed Assets 221 5,528 221 5,749 0 5,749 5,749 from different
sources (cash,
Goodwill 0 24,098 24,098 24,098 24,098
investments, new
Investments 3,963 17,965 3,963 21,928 0 21,928 -17,965 3,963 debt raised)
Other Assets 5,621 37,793 5,621 43,414 0 43,414 43,414
Cash & Equivalents 675 2,824 675 3,499 0 3,499 -2,824 675
Total Assets 10,480 64,110 10,480 74,590 24,098 98,688 -20,789 24,098 77,899

Sales 2,322 9,926 12,248 12,248 12,248

Expenses 2,080 5,960 8,040 Goodwill 8,040 8,040
Operating Profit 241 3,966 4,207 (consideration 4,207 4,207
paid – net assets Cost of Funds @
Other Income 496 506 1,002 1,002 1,002 10% on total value
received)
Interest 226 2,680 2,906 2,906 2,875 5,781 of Rs. 28750cr
Depreciation 17 766 783 783 783
Profit before tax 495 1,026 1,521 115cr shares 1,520 -1,355
Tax % 35.6% 70.2% 58.9% issued to 70.2% 70.2%
Net Profit 319 306 625
shareholders 453 -404
of A
EPS 13.9 1.7 1.5 -2.3
# of shares (cr) 23 178 293 178
EPS accretion / dilution 20% -183%

Alok Katre 02/01/2024 9

 VALUING M&A DEALS
 Typically, a firm would use NPV analysis when making acquisitions.

 The analysis is straightforward with a cash offer, but it gets complicated when the consideration is stock.

SYNERGIES

 Synergy is the additional benefit obtained from combining the firms.

 Synergies can stem from many sources:

 Revenue synergies: additional sales such as from cross selling of products, new geography covered, etc)
 Cost synergies: cost reduction such as due to economies of scale, cutting duplicate spends (R&D, S,G&A, etc)
 Financial synergies: e.g. lowering of risk, additional debt capacity, lower tax rate, capex rationalisation, etc

 Synergy value = Value of combined firm ‘AB’ – (Value of A + Value of B)

 Often synergies are expressed as annual amount: So, PV of synergies = 1/WACC (i.e. perpetual annuity)

 Synergies are usually not achieved in year 1 after deal (but take 3-5yrs), time value has to be factored in.

Value of combined firm post the deal

 Value ‘AB’ = Value A + Value B + (PV of Synergies – deal premium paid to A) – PV of deal costs

Most of the times the entire NPV (i.e. PV of synergies – cost of deal) is given to the target firm’s
shareholders as a ‘premium’ i.e. most deals are zero NPV or NPV negative for acquirer

Alok Katre 02/01/2024 10

 M&A: VALUATION ANALYSIS
 Example: Lets assume our combined Firm AB gives us the following inputs:
 Cross-selling opportunity = Rs. 1000 crore per year (i.e. additional sales per year = “revenue synergies”)
 They can reduce combined expenses/costs by 2% (i.e. “cost synergies”)
Synergy valuation Rs. Crore Comments
Sales synergies 1,000 = Value of additional synergies
Profit on extra sales 343 = Sales * profit margin (preferably gross margin, else EBIT margin)
Costs synergies 161
Total Annual synergies 504 = Profit on extra sales + Cost savings/synergies
Present Value of synergies 5,043 Annual synergies are like perpetual annuity, so PV = 1/WACC
(this is the total value creation from the deal)
Market Value firm A 23,000
Market Value of firm B 44,500
Value of Combined Firm AB 72,543 Combined value of the firms increases by value of synergies

Firm B shareholders
Firm A shareholders Premium paid >
Synergies, i.e. value Market value pre-deal 44,500
Market value pre-deal 23,000 transfer from B to A + PV of Synergies 5,043
+ Premium received 5,750
- Premium paid to A - 5,750
= Share of combined firm 28,750
= Share of combined firm 43,793
EPS accretion is presented as a key measure of a deal’s attractiveness, but in reality share of value and
post-deal RoCE is key

Alok Katre 02/01/2024 11

 ANALYSING MERGER DEALS
 No two merger deals are the same… but here is a 5 step framework

 Strategic rationale: What is the rationale of the deal? Does it chime with the industry dynamics
and does it meaningfully change a firms positioning? Beware of deals for just “bootstrapping
earnings”
 Synergies: What are the synergies from the deal? What are the sources of synergies? What is
the time frame and trajectory of these? Is the management being aggressive or conservative?
Will these be identifiable, tracked and reported regularly to the market?
 Deal structure: Is it a simple ‘A+B’ or is a complex maze of structures? One has to look through
complex structures to the economic reality and perhaps the real motive of the deal. Complex
structures create a fog and are not appreciated by the market..
 Valuing the merger: what is the value of the combined entity and importantly the value of the
synergies? Is 1+1 >2? Which shareholder group is getting a greater share of benefits (usually it
is the target company). Structures with share components need bit more complex valuations…
 Share prices quickly adjust to reflect the market’s opinion of the deal’s value and benefits to the acquirer or
target company

 Timelines, regulatory risk, etc. Are there any risks from Competition authorities? Will remedial
actions be required and what is the impact of those? Are major shareholders with the deal?

Alok Katre 02/01/2024 12

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Alok Katre 02/01/2024 13

 DIVESTITURES & SPIN-OFFS
 Corporates also resort to selling assets or businesses not just acquiring them.

 Divestitures refer to sale of business division or asset to a third party buyer;

 Spin-off refers to creating a separate listed entity from an existing division with the same set of
starting shareholders as the listed parent entity - also called as “carve-outs”
 Multiple reasons:
 In the 80s and 90s, conglomerates were “in fashion” and considered a way of “diversifying” risk.. That has
since changed with focussed companies delivering better returns financially and on the stock markets.
 Changing technology – e.g. shift to LED bulbs from conventional forced both Philips and Siemens to
divest their lighting divisions.
 Need to be more nimble/accountable: in a sprawling conglomerate smaller businesses compete for
capital and management time with larger ones or hide behind large successful divisions; decision making
gets stuck in bureaucracy
 Unlocking value: a strong reason for separating non-core businesses within a conglomerate by reducing
complexity and via reducing conglomerate discount
 E.g. Siemens Healthineers and Danaher: Healthcare business undervalued being housed in a Industrial Company
 L&T’s spin-offs of L&T Infotech & L&T Finance business, sale of Electricals (to Schneider).

 Reduce conglomerate cost burden: e.g. Siemens Healthineers and Wind Power saw “group” overhead
allocations reduce by 3-4% of their sales – dis-synergies of being within a conglomerate

Alok Katre 02/01/2024 14

DO SPIN-OFFS CREATE VALUE? PHILIPS’ EXAMPLE

Philips share price (€)

Alok Katre 02/01/2024 15

 SPIN-OFFS AND VALUE: DANAHER EXAMPLE

180 250
160 Danaher Fortiv Danaher HC adj. Fortiv adj

140 200

120
150
100
80
100
60
40 50
20
0 0
Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19

Alok Katre 02/01/2024 16

SPIN-OFFS: BAJAJ AUTO IN INDIA, A CLASSIC EXAMPLE
2000 Bajaj Holdings Bajaj Auto Bajaj Finserv Total
1800 Erstwhile Bajaj Auto
shareholders got 1 share
1600 each of Bajaj holdings, Bajaj
Auto and Bajaj Finserv..
1400 Note the effective spike up in
share price (ex-spin-off from 13
1200 March)

1000

800

600

400

200

0
Oct-08

Oct-09
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08

Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Jun-09
Jul-09
Aug-09
Sep-09

Nov-09
Dec-09
What happened to price of each
component until 2020 is well
known!! Makes for a “textbook”
case of spin-off benefits..

Alok Katre 02/01/2024 17

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Alok Katre 02/01/2024 18

 CASE STUDY… (WIND TURBINE INDUSTRY)
 Siemens and Gamesa have signed binding agreements to merge Siemens’ wind power business, including
wind services, with Gamesa to create a leading global wind power player. Siemens will receive newly issued
shares of the combined company and will hold 59 percent of the share capital while Gamesa’s existing
shareholders will hold 41 percent. As part of the merger, Siemens will fund a cash payment of €3.75 per share,
which will be distributed to Gamesa’s shareholders (excluding Siemens) immediately following the completion
of the merger (net of any ordinary dividends paid until completion of the merger). The cash payment
represents 26 percent of Gamesa’s unaffected share price at market close on January 28, 2016.

 Additionally, Gamesa and Areva have entered into contractual agreements whereby Areva waives existing
contractual restrictions in Gamesa’s and Areva’s offshore wind joint venture Adwen, simplifying the merger
between Gamesa and Siemens. As part of these agreements, Gamesa – in alignment with Siemens – grants
Areva a put option for Areva’s 50 percent stake and a call option for Gamesa’s 50 percent stake in Adwen.
Both options expire in three months. Alternatively, Areva can in this time divest 100 percent of Adwen to a third
party via a drag-along right for Gamesa’s stake.

 Siemens and Gamesa expect significant synergy potentials in a combined setup. In total, annual EBIT
synergies of €230 million are expected in year four post closing. Closing is expected in the first quarter of
calendar year 2017.

 Press release: https://www.siemensgamesa.com/-/media/siemensgamesa/downloads/en/investors-and-

shareholders/cnmv-filings/2016/20160617-project-pioneer-hr-firma-contrato-de-fusion-eng.pdf

 Presentation: https://www.siemensgamesa.com/-/media/siemensgamesa/downloads/en/investors-and-
shareholders/cnmv-filings/2016/20160617-analist-presentation-2.pdf

Alok Katre 02/01/2024 19

THE RATIONALE: LEADERSHIP, SCALE, COMPLEMENTARITY

Alok Katre 02/01/2024 20

THE RATIONALE: LEADERSHIP, SCALE, COMPLEMENTARITY

Alok Katre 02/01/2024 21

COMPLEMENTARY REGIONAL EXPOSURES AND FOOTPRINTS

Alok Katre 02/01/2024 22

COMPLEMENTARY PRODUCT PROFILE…

Alok Katre 02/01/2024 23

 DEAL SYNERGIES…
NPV of merger =
PV value of post-
tax synergies to
perpetuity

 There are some other sources of synergies in M&A deals…

 Tax losses of the target (Net Op. Loss or NOL), such as from losses in one part of the business or from tax holidays, etc.
 Debt capacity: if target is underleveraged + higher debt capacity from lower risk of larger firm and higher profits post
synergies
 Reduced Capex and/or working capital due to efficiencies of scale and removal of overlaps..

Alok Katre 02/01/2024 24

MERGER OF EQUALS OR REVERSE MERGER?

Alok Katre 02/01/2024 25

DEAL STRUCTURE…

8.1%

Merger deal, but

effectively
Siemens was the
acquirer of
Gamesa!!!

Alok Katre 02/01/2024 26

PROFORMA FINANCIALS – GAMESA…

Simple “A+B”
concept until
EBITA line

Deal specific
items, costs,
etc

Value of new firm =

Value of Siemens
Wind
+ Value of Gamesa
+ PV of Synergies

Net effect
1+1>2 due to
synergies

Alok Katre 02/01/2024 27

PROFORMA COMBINED FINANCIALS…
Gamesa: pro forma P&L following the deal
€m; y/e December 2015a 2016e 2016 pf. inc. 2017e 2017 pf. Incl.
Siemens Siemens
Wind Wind
Sales post synergies 3,504 4,290 10,431 4,588 10,921
% change 23.1% 22.4% 17.4% 6.9% 4.7%
EBITA post synergies (€m) 320 419 989 468 965 Important when
there is a cash
EBITA margin post-synergies 9.1% 9.8% 9.5% 10.2% 8.9%
component to the
Financial charges -44 -30 -12 -12 7 deal
Deal financing costs 0 0 0 0 0
Associate income -25 -23 -23 -12 -12
Pre-Tax income 251 367 954 444 960
EPS accretion a function of:
Taxes -76 -101 -263 -119 -257
- Cost of financing vs EBIT/Cost of
Tax rate 30.2% 27.6% 27.6% 26.7% 26.7% acquisition
Minorities, disc ops, etc -7 -1 -1 -1 -1 - Relative valuation of the target vs
the acquirer (if acquirer trades at
Net income 168 264 689 324 703 higher PE than target, EPS
No. of shares 276 276 678 276 678 accretion will be a given (without
any takeover premium)
Diluted EPS (ex-PPA) 0.61 0.96 1.02 1.18 1.04
Diluted EPS (ex-PPA, restructuring) 0.54 0.96 1.02 1.18 1.22
% accretion 6.3% 3.8%

EPS accretion is presented as a key measure of the attractiveness of the deal, but in reaiity RoCE is
where the real story lies…

Alok Katre 02/01/2024 28

IMPACT ON ‘ACQUIRER’

Alok Katre 02/01/2024 29

VALUING THE DEAL…
Target EV/EBITA multiple Comments
€m; y/e December 9.0 10.0 11.0 12.0
Sales of Gamesa-SIE Wind 11,981 11,981 11,981 11,981 11,981 2019e, including revenue synergies
Reported EBITA of Gamesa-SIE Wind 1,279 1,279 1,279 1,279 1,279 2019e, including revenue and cost synergies In an all cash deal
Margin 10.7% 10.7% 10.7% 10.7% 10.7% arriving at the
value paid to the
EV of combined business (2018 end) 11,514 12,793 14,072 15,352 target is easy…
Combined EV (2016 end) @ 8.2% WACC 9,835 10,927 12,020 13,113
Net Cash in the JV 1,212 1,212 1,212 1,212 Gamesa's €479m net cash (2016e), to be matched
by Siemens + €250m cash against provisions
Provisions from Siemens -250 -250 -250 -250 Provision for bearing and other operational issues
Equity value of combined business (2016 end) 10,796 11,889 12,982 14,075
Siemens’ share in combined entity 59% 59% 59% 59%
Gamesa’s share in combined entity 41% 41% 41% 41%

Initial cash outflow for Siemens 1,766 1,766 1,766 1,766 €3.75/Gamesa share special payout + other
contributions
Value for Siemens Wind 4,604 5,248 5,893 6,538
EV/Sales for Siemens Wind 0.75 0.85 0.96 1.06
EV/adjusted EBITA for Siemens Wind 8.1 9.2 10.4 11.5 Value of the deal for
Gamesa shareholders =
Equity value attributable to Gamesa 4,427 4,875 5,323 5,771 41% of new entity
Special dividend for Gamesa shareholders 1,035 1,035 1,035 1,035 €3.75/Gamesa share special payout +
Implied equity value paid to Gamesa 5,462 5,910 6,358 6,806 41% of synergies
# of Gamesa shares outstanding 276 276 276 276 +
Per share value offered to Gamesa (excl. Adwen) 19.8 21.4 23.0 24.6 upfront cash (equating
to 60-65% of PV of
Value of Adwen stake + loans to Adwen 171 171 171 171 €74m share of equity + €97m loan by Gamesa to
Adwen. Taken at Book value synergies on after tax
Value for Gamesa shares including Adwen 20.4 22.0 23.6 25.3 basis)
2016e EV/Sales paid (ex-Adwen) 1.1 1.2 1.4 1.5
2016e EV/EBITA paid (ex-Adwen) 11.7 12.8 13.8 14.9

Alok Katre 02/01/2024 30

ALL CASH DEAL – SCHNEIDER’S ACQUISITION OF L&T E&A

Despite an all cash deal,

the value for the deal
has to be inferred from
the available
information…

Alok Katre 02/01/2024 31

ALL CASH DEAL – SCHNEIDER’S ACQUISITION OF L&T E&A

EPS accretion is important, but more than

that is the RoCE post synergies…

Comparing RoCE to WACC will tell us

whether deal was value creative or not

Alok Katre 02/01/2024 32

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Q&A

02/01/2024 33