Cross Border M&A Deals ‘Cross Border Mergers and Acquisitions (CBMA) refer to the acquisitions made by cam- panies in foreign countries. Such transnational or CBMAs have been motivated by a variety of strategic considerations, which often differ Erom those which drive purely domestic acquisitions. The path towards CBMA, is not a straight forward approach or extension of the path adopted for domestic mergers and acquisitions. CBMAs are much more complex due to differences in the political and economic environment, corporate culture and organization, tradition and conventions, tax rules, law and accounting prin- ciples between the countries of the acquirer and the target company. CBMAs particularly are those with giant transnational companies spending vast sums of money to takeover firms in other countries and one of the most visible facets of globalization. While mast such M&As take place within the developed world, they are also increasing in importance in the developing countries (largely in the form of acquisitions since mergers with local firms are relatively uncommon) RECENT TRENDS AND PATTERNS: ‘The global M&As landscape as sourced from Dealogic' suggest that after three consecutive year-on-year increases, global MécA dropped to 3.84 trillion USD in 2016 from 4.66 trillion USD in 2015 (an annual record high}, namely a decline of 18% year-on-year. Although CBMAs was down by 3% globally year-on-year, China’s outbound volume hit a record high (225.4 billion USD) as did US inbound M&As (486.3 billion USD). October 2016 was the biggest month on record for global M&As, with 6008 billion USD (PWC, 2017).326 CROSS BORDER MA DEALS 1 Global MBA deal waive (Sin) — MBA an a Seat GOP PEEEEEEREG TE 2008 "2007" aos" 2009 amo "2a" ao” ama” aoa" ams * ate FIGURE 18.1: GLOBAL M&As ACTIVITY Sources: Lt Morgan, Dewlogle ani! IMF GOP farceasts as of January 10, 20/7; M&A as a % of GOP is rounded ta the nearest decimal The M&As landscape in India started changing after the introduction of liberalization programme in 1991. The regulatory policy changes coupled with perceptive change in outlook towards foreign capital and technology led to structural transformation of the Indian Industries. This industrial transformation has provided a launch pad for the cor- porate enterprises to grow and expand through M&As. The available literature on M&As. indicated towards predominance of domestic deals prior to mid 1990s. Later on CBMAs started taking headlines in the Indian M&A scenario. This gives a hint of large number of MNEs have used CBMAs to enter into Indian market and strengthen their presence. As a result, around 40 per cent of the FDI during the early phase of economic reforms came into the Country through CBMAs (Kumar, 2000; Saha, 2001). Even though Indian M&A scenario is still on smaller scale, a substantial proportion of FDI came through CEMA route as has been depicted in Figures 18.2 & 18.3 (Kar et al, 2015).50000.0 ~ 40000.0 + 30.000.0 20:000.0 + 19000.0 BRGGESRR REE FIGURE 18.2: TREND OF FDI INFLOWS AND INBOUND M&As, 190.2012 (IN MILLION US $j Source: Compiled ont UNCTAD clita ‘The increasing level of investment through CBMA and its emergence as a major compo- nent of FDI has led is to think why firms are engaging in border crossing activity instead ‘of establishing or subsidiaries for propelling growth. In case of India, CBMA has became ‘one of the major components of FDI as has been observed from Figures 18.2 é 133. For India, in fact, outbound CBMAs were almost non-existent before 2000. However, the border crossing activity by the Indian Inc. Started gaining momentum since 2000, when the value of the deals reached $589 million followed by $1875 million in 2001(Kar et al, 2015), This was the period when Tata Tea acquired Tetley and created history by becom- ing the first Indian Company to successfully execute leverage buy out deal. 30000 30.000.0 250000 + 20 000.0 + — FH 15 000.0 5 Suttons 10 000 ~—_____________, —— 50000 | sme PP LOSS SPO SE FIGURE: 18.3: TREND OF OFDI AND OUTBOUND M&As, 1990-2012 (IN MILLION §) Sauree: Compiled from UNCTAD dataInspite of the global financial crisis im 2008, India has bounced back to its top level of 2006-07, unlike the other North America and Europe. The reason behind India’s recovery could be undeniable attractiv and importance of emerging markets. According to. a report by Accenture? the main driving farce of Indian CBMAs is the search for top line revenue growth through new capabilities and assets, preduct diversification and market entry. The trend is not driven purely by opportunistic factors as Indian companies are in many cases motivated to look abroad in response 10 newly competitive, complex or risky domestic markets or to find capabilities that are lacking in India. ‘On the outbound front, India targeted mainly the IT, Telecom and pharmaceutical sec- tors. The M&As involving Tata-Chorus, Tata-JLR, Hindalco-Novelis, Sun Pharma- Terapia, Airtel- Zain Africa, DIS-Ranbaxy and Sun Pharma-DIS (India) have generated lot of media interest. The way companies has achieved phenomenal growth momentum by adopting this strategy has earned them lot of accolades. However, a close scrutiny of the geographic distribution of the Indian Outbound Deals tells a different story. The analysis of the data reveals that maximum deals go to North America (40.08%), Europe (30.77%) and followed by developed capital markets of Asia (15.38%). One of the most important finding of this pattern indicates that Indian companies have targeted at the developed capital markets for grewth and expansion (Kar et al,2015). Similarly, continent wise distribution of inbound Mé:As in India prominently shows that North America has accounted forthe largest percentage of M&As with 32.8 "and Europe 28.86% of total, followed by the other continents (Kar et al, 2015). For the global MNCs, India has the world’s best resources with cheap but talented labour, largest markets in. terms of size, vast capital markets, advanced technologies and lowest-cost suppliers of inputs (Das, 2007), MOTIVATIONS FOR CBMAs Though we have already discussed the motivations of Mé&As in general in the first chap- ter, yet some of the specific motivations for CBMAs may be of a different nature.Hence, there is a need to understand the nature of motivations in case of CBMAs. Realisation of Synergies ‘CBMA can lead to a creation of value measured by joint returns if the cash flows of the merged firm are greater than the sum of its parts, namely the cash flows of the two stand-alone firms. The creation of value could be due to synergies resulting from the transfer of technology and skills between the two firms that increases the profitability in one or both firms. Synergies may also accrue to the acquiring firm if the acquisition provides access to the targets market or allows the acquiring firm to vertically integrate its lines of production. Similarly, synergies can be achieved through cost reduction in the combined firm. Overall, positive synergies will increase the value of the combined firm, Some of the Indian companies who had undertaken CBMAs, reported about resultant synergies. The acquisition of German based software firm ASG provides synergy to Infotech's software service offerings in the European markets. The acquisition of USbased Ivory Consulting group has complemented ICICI Infotech's financial strength, domain expertise, project management experience and world class infrastructure? The Asian Paints acquisition of SCIB Chemical SAE Egypt has complemented the business operations of Asian paints.’ Tatas emphasized to strengthen specific parts of their value chain and developed integrated offerings globally. Access to Capital If the cost of capital is higher in the target market, which is likely if the target is located in a developing country, then a CEMA could create value by providing the target with access to a lower cost of capital through the internal capital market in the combined firm. If this is the case, projects which would otherwise not be undertaken by the target firm may become profitable and be a source of value creation. During financial crisis, the cost of capital is likely to increase even further in emerging markets, creating even more of an incentive for CBMAs and possibly bigger gains from the acquisition for cash-strapped targets. Access to Some Specific Assets ‘One of the motivations of CBMAs may be motivated to have access to company specific intangible assets like goodwill, brand name, technology and expertise of manpower. The recent cross border acquisition of Corus by Tata Steel, Jaguar and Land Rovers by Tata Motors, Novelis by Hindalco bears testimony to this aspect. In the recent past, Ranbaxy Laboratories Lid. has got access to the state of the art testing and quality assurance ca- pabilities and advanced research capabilities towards controlled substances when it has acquired the liquid manufacturing facility of the US based Signature Pharmaceuticals in July 2002." Further, Infosys’s CBMA of Australian firm, Expert Information Services added about 330 manpower and ensured accessibility to domain expertise in the telecom vertical and project management* Overcoming Constraints from Limited Home Market Growth The location of acquisition also reflects the strategies of Indian Acquirers. Altered by the markets and higher value offerings of the developed economies, Indian Companies are making vast majority of their transactions in North America, Europe and the developed regions of Asia. A close look at the CBMA profile of Indian companies proves this factor. The acquisition of Tetley Tea by Tata Tea gave them a tremendous boost in the European and North American Markets. Acquiring Control Previous research suggests that the acquiring control is important in the presence of proprietary assets and less common in labour-intensive industries (Moran, 2001). Theacquisition of majority control may also be more important in countries with poor protection and enforcement of the minority shareholder rights (La Porta, Lopez-de- Selanes, Shliefer & Vishny, 1999). Consistent with this view previous research shows that partially-owned affiliates of US multinational companies receive less taining, use older technologies and export less to their parents than their wholly owned counterparts (Desai, Foley & Hines, 2003) If the transfer of control leads to an increase in investment and transfer of technology, joint returns should increase with cantroL Acquirers may also gain from acquisitions that achieve control of the target firm. This gain may be the result ‘of total gains being higher and the target and acquire split these gains ina constant ratio. Alternatively, acquirers could pay different prices when they acquire control of the target. The impact of the foreign acquirer gaining majority control on the targer’s stock price is less clear. On the one hand, if the market expects that the acquirer will transfer bet- ter technology and provide access to cheaper capital to the target its stock price will increase. On the other hand if the foreign acquisition dilutes the ability of the previous owners to exercise private benefits of control, the target's stock price may falll (Dyck & Zingales, 2004). STRATEGIES FOR CBMA The decision to go for CBMA may be centered around some strategic considerations which are stated as below: ‘Strategic Selection Acompany must choose from among the countries in the world where it wishes to do ‘business. This is a strategic decision, perhaps based on lowering its production costs or on ‘opening new growth prospects. The choice of made is also a strategic choice, based both ‘on its internal resources and experience, but is also related to the choiee of country, as ownership restrictions and norms of deal type exist by country. Within a country-mode choice context, a set of potential partners must be screened and a deal candidate found. However, the order of these choices in by no means country, mode, partner and instead is quite likely to be partner, then made, based on where the partner country is. Analysing Country Specific Rules and Restrictions The choice of country must also include the business rules and taxation risks and op- portunities. Tax rules and treatments differ tremendously by country. These include the treatment of capital gains, treatment of the ability to carry forward losses, and account- ing rules for the treatment of inventory, among others. The tax and accounting rules in the country severely limit the ability for certain deals to make financial sense or change the choice of mode to maximize any tax benefits and mitigate risks. Further, in choosing a particular country or the mode of entry within the country chaice, certain other considerations are important. Certain countries place restrictions on the foreign ownership of domestic firms, assets, and real property. In addition, operating in those countries may be difficult based on the difficulty of getting travel visas for person- nel to move freely between the firns's locations. The legal environments differ around theglobe, making protection of intellectual property more or less difficult. In more unstable legal environments where property rights protection laws differ, this may extend to greater risk that foreign courts or governments may actually appropriate firm assets. Further, exchange restrictions can be a burden in ongoing operations, as certain foreign countries without freely traded and floating currencies may restrict the repatriation of profits, ‘Cultural Compatibility and Integration The cultural compatibility of the two companies must be assessed in advance and if necessary corrective mechanism needs to be placed as discussed in the previous chapter. While international cultural differences are commonly anticipated, the firms themselves may differ from country norms, making things either easier or more difficult. Another element of cultural difference involves the leadership and governance norms (beyond the legalities of governance). These elements of culture may affect every element of both accomplishing a deal and operating the entity from going forward. When the CBMA results in a failure or may not be clinched due to unavoidable circum- stances, then no option is left other than exiting from the venture. Hence, it is pertinent to consider its exit options before signing CBMA agreements. Such a future exit may be for either planned reasons or as a method to recover from a failed integration or poorly performing operations. The market of potential buyers for a failed foreign deal may be limited and thus illiquid, making an exit even more difficult. Certain foreign governments may also impose restrictions on the sale of the firm, as well as make the proceeds from the sale more difficult to repatriate. The bottom line is, a firm should build into its con- tingency plans so that exiting may be difficult, time-consuming, and costly. EXECUTION OF CBMA Executing a CBMA deal follows almost the same processes like that of a domestic deal. However, here there are additional complexities and procedures to be considered. Negotiation CBMA negotiations are more complex because they include additional negotiated ele- ments and must differently negotiate with others. For example, the consideration to be paid must also include exchange rate fluctuations, choice of payment terms and cur- rencies, and who will bear the costs of exchange costs. While firms normally agree on a choice of governing law, this decision must be made within the allowable bounds of their existing jurisdictions, and they may choose different governing laws for different portions of the agreement. Valuation As we know, valuation is a very complex and debated issue. It is all the more complex for CBMA decision. For example, the cost of capital may be different in different coun- tries which will have a bearing on financing of the deal. The valuation exercise needs to include the exchange rate uncertainty in valuing the cash flows, under the assumptionthat repatriation or international trade is the goal. The valuation also needs to consider the tax and accounting rules of the specific countries where it aims to acquire. ‘Structure of the Deal The legal, accounting and allowable tax structures for M&As differ from country tocoun- try. Based on this, the choice of CBMA made may be limited or the parties are forced to make certain structural decisions based on what the laws allow. Internal Approvals: Itisanimportant considerationsince each country hasits own laws regarding stockholder and board voting requirements for the approval of different deal types and perhaps specific to cross-border deals. External Approvals: For various philosophical and political reasons, countries around the worid differ in their willingness to allow foreign buyers and sellers to do deals with their domestic firms. Ax such, CBMA deals may face additional serutiny and will need to gain approvals from additional regulatory bodies. Because regulatory bodies from each country may battle for jurisdiction, these processes may be unclear. Of course, the filing and disclosure re- quirements, as well as the process timelines, differ by country, making this a potentially onerous process. Due Diligence Process Different countries require different levels of reporting and record keeping, exacerbat- ing the ability to evaluate a firm. At the individual level, there may be different norms of honesty and transparency that make due diligence more or less difficult. BMA - INTEGRATION ASPECTS. Integration aspects in a CBMA is generally much more complex and often lands in problems, The integration aspects which are discussed in Chapter 17 are also relevant to CBMA. It is probably not an exaggeration to assert that mast CBMA deals run into trouble because of failures in the integration process. Thisis based on the fact that target company employees and managers tend to be unfamiliar with the language, managerial behaviour and carporate custom of the acquirer. They need to be reassured even more than in a domestic context of the intentions of the acquirer. In the post deal scenario, communications to and among the numerous additional stakeholder groups must be done. The retention of the employees will vary based on differing tolerances forambiguity during the change phase. Different labour laws in different regions of the world further makes it more complex to sack personnel to achieve post merger integration goals, The integration of accounting and financial system may force additional and new ac- counting practices to comply with the reporting requirements in the designated country. Further, the foreign acquirer is likely to need the services of the incumbent management since without them, continuity may not be preserved. But this is not to be followed incase of a turnaround strategy where the acquirer needs to install a new management team after acquisition. This chapter has described the nature of CBMAs. The pattern and trends of Indian CBMA has been illustrated which include both inbound and outbound CBMA deals. The specific motivations related to CBMAs have been stated. The Chapter hasalso examined the'strategic considerations aspects involving CEMA deals are briefly stated. The Process of Deal Making Firms may consider hundreds of Mé&As ideas, approach some of those and engage in serious discussion with even less and go forward in the M&A path perhaps with one. After passing many of the hurdles in execution effectively, the deal is negotiated and agreed upon by the parties through proper due diligence and is then clinched, The announced deal generally has an intended closing date. NEGOTIATING THE DEAL M&A deal making starts with the negotiation process. In this negotiation, two or more parties representing different intereststtemp! toachieveaconsensusonseveral issues. The negotiating team generally comprises investment bankers, lawyers and legal consultants, accountants and senior executives of the firms. Investment bankers provide strategic and tactical advice to clients; screen potential buyers and sellers; often make the initial contact;arrange financing; and provide negotiation support, valuation, and deal structuring guidelines. Typically, lawyers and legal consultants are closely involved in structuring the deals. They carry out due diligence, evaluation of risks, negotiating many of the terms and conditions, drafting important documents and coordinating the timing and sequence of events to complete the transaction. Accowtants provide input into M&A negotiating and deal structuring on tax and financial structures and on performing financial due diligence; they also prepare financial statements. The key role of senior executives in the negotiation process is to provide strategic and practical justification for the proposed combinations strategy, offering their practical operating experiences to help everyone 336understand the practical implications of what is being proposed. Their input is crucial because they are ultimately responsible for executing the acquirer’s business strategy and integrating the target and acquiring businesses to achieve business plan objectives. DUE DILIGENCE ‘The literal meaning of due diligence is persistent application to one’s work. In the present context, it refers to the detailed investigation process by an investor or his advisors for the target company’s business. It includes investigation of the assets and liabilities of company or business. Further, it covers investigation into compliances with the various regulations affecting the operation of a company or business. The need for carrying out due diligence process evalves from the legal concept “caveat emptor’, ‘let the buyer beware”. Thus, it is expected from the acquirer/investor etc. to take utmost care 10 examine various aspects of the prospective target company. Due diligence influences decisions such as whether to make an investment, whether to choose one joint venture partner or another, what disclosure should be included in an offer document for issue of securities whether listed om a stock exchange or otherwise, whether to lend finance to a borrower for a project, whether a party to an agreement is capable of performing its contractual obligations. TYPES OF DUE DILIGENCE Broadly, due diligence practices can be categorized intotwotypes.One is the ‘Anglo-Saxon’ practice. This involves comprehensive legal and financial due diligence and significant disclosure before the signing of an agreement. Contrast this with the practice in much ‘of the rest of the world, which invelves mare modest preliminary legal and financial due diligence with correspondingly limited disclosure. TABLE 19.1 - THE PROCESS OF DEAL-MAKING Preliminary steps | Sigming che definitive ac “Acquirer identihes Ducdiligencecontinucs | # Announcetransc-| # Announce Acquirer counsel pre tion publicly f pares and vets inters| # Apply for required | @ Satisfy any nallythedraftdefmitive | governmentalcon-| _post-cloxing acquisition agreement | sents covenants © Acquirerpresentsdmaft | # Obtain required defmitivesgreementto| third party con- ers) conduct valu. ation and ex Target sents © Negotiate definitive | # Finalize all related agreement transaction id. of fic @ Acquirer counsel pre.| "ents am am pares and vets inter-| Ttificates : Hold shareholders to the definitive agrees meeting {typically ment (escrow agree-| Target only) ik F i FPreliminary steps | Signing the definitive ac+ ment, voting agree| # Exchange final ments, employment] executed agree- agreements, tax and ments, legal opine porate legal opin | ions, and officer's ions, affiliate letters, certificates etc) ‘Target prepares disclo- sureschediles possibly ccapttalization tables Held board mecting(s) to approve transaction Target may get fairness opinion from its bank erst this time Sign definitive agrees ment.deliverdisclasure schedules Financial Due Diligence Financial due diligence involves critically examining the target legal company's historical, current and prospective operating results as disclosed/discharged/obtained from the following sources. 1. Audited financial statements. 2 Unaudited finaneial information 3. Financial information with stack exchanges and regulators regulation. 4. Tax returns 5. Cash flow statements etc. Generally, the process starts at a comprehensive analysis of the balance sheet. A review ‘of the target firm’s financing and capital structure is very much required. Further, this, analysis should include details of short-term and long-term borrowings, the percentage of debt and equity ratios in the company’s balance sheet, interest and fixed charges coverage ratios etc. Financial due diligence also involves analysis of the cash flow statement. One must not forget to examine the quality of company’s relationships with its lenders and an ultimate opinion concerning the reliability and credibility of its financial statements. Legal Due Diligence ‘Legal due diligence involves the practices of addressing certain fundamental legal. issues which include good compliance practices as per the Companies Act, SEBI Act, Income-tax Act and other corporate legislations. Analysis of legal due diligence process. could be undertaken from the fallowing sources.() Memorandum of Association (i) Articles of Association (ii) Target company’s prospectus (iv) Documents filed with Registrar of Companies including registration of charge. (¥) Title deeds of properties (v2) Tax return and compliance certificate (vi) Environmental law compliance (vii) Lending agreement, covenants and borrowing powers. (i) Compliance with any special industry legislations (3) Labour agreement, compensation ete. (xi Pending litigation Today's legal environment has become highly specialized. Today, even mid-sized deals invalve battery of corporate tax, real estate, environmental, employee benefits, insurance and other kinds of legal professionals. Further, legal due diligence requires carefulattention toactual and threatened litigation. Litigations can emerge from various statutary bodies, shareholders, debt holder, suppliers, assistance product liability etc. Further, in the era of increasing regulatory and judicial scrutiny, matters like allegations of improper behaviour by corporate officers, directors and emplyees, workplace safety matters, employee benefits, potential equal opportunity violations and ever increasing environmental scrutiny may take center stage. Operational Due Diligence Operational due diligence includes investigating the target's intellectual property, its production, its sales and marketing efforts, its human resources and the other operational issues. Meaningful generalization of operational due diligence practicesis difficulttomake as it varies from target to target. Operational due diligence practices can be undertaken by analyzing the information from the following sources: ( Newspaper and magazines reporting about the target company. (i Available information with trade associations, chambers and regulatory bodies. (ii) Market reports. (i) Company journals, brochures and websites, (¥) Gathering inputs from the market, market experts, suppliers and customers (vi Interviewing the employees, ex-employer ete. One has to appreciate that preparation of any due diligence report is as good as the persons who conduct it and the correctness of the information gathered. In the case of operational due diligence it is more often very subjective, depending upon the person wha is interviewed to gather the information and one may be able to only estimate the future profitability. The success of due diligence process will depend on the quality and quantity of data collected or supplied.