Mergers and Acquisition

Acquisitions and Takeovers An acquisition may be defined as an act of acquiring effective control by one company over assets or management of another company without any combination of companies. Thus, in an acquisition two or more companies may remain independent, separate legal entities, but there may be a change in control of the companies. When an acquisition is 'forced' or 'unwilling', it is called a takeover. In an unwilling acquisition, the management of 'target' company would oppose a move of being taken over. But, when managements of acquiring and target companies mutually and willingly agree for the takeover, it is called acquisition or friendly takeover. Acquisitions and Takeovers Under the Companies Act (Section 372), a company's investment in the shares of another company in excess of 10 percent of the subscribed capital can result in takeovers. An acquisition or takeover does not necessarily entail full legal control. A company can also have effective control over another company by holding a minority ownership. What is M & A? Mergers and acquisition looks tempting and easier from the seashore but in reality its a deep sea whose secrets are difficult to learn and imbibe. Its a process which is so much complicated that a small mistake and the company involved is bound to be doomed and successful vice- versa. What drives M & A? The valuation differences of the share prices lead to Acquisitions of firms that are low-valued from the viewpoint of outsiders (M.Gort 1969). Lower interest rates also lead to more Acquisitions, as Acquiring firms rely heavily on borrowed funds (R.Melicher et al 1983). Types of Mergers Horizontal merger:- is a combination of two or more firms in the same area of business. For example, combining of two book publishers or two luggage manufacturing companies to gain dominant market share. Vertical merger:- is a combination of two or more firms involved in different stages of production or distribution of the same product. For example, joining of a TV manufacturing(assembling) company and a TV marketing company or joining of a spinning company and a weaving company. Vertical merger may take the form of forward or backward merger. When a company combines with the supplier of material, it is called backward merger and when it combines with the customer, it is known as forward merger. Conglomerate merger:- is a combination of firms engaged in unrelated lines of business activity. For example, merging of different businesses like manufacturing of cement products, fertilizer products, electronic products, insurance investment and advertising agencies. L&T and Voltas Ltd are examples of such mergers. Advantages of Mergers & Acquisitions

Accelerating a company's growth, particularly when its internal growth is constrained due to paucity of resources , Enhancing profitability ,Diversifying the risks of the company, A merger may result in financial synergy and benefits for the firm in many ways Limiting the severity of competition by increasing the company's market power. Advantages of Mergers & Acquisitions Accelerating a company's growth, particularly when its internal growth is constrained due to paucity of resources. Internal growth requires that a company should develop its operating facilitiesmanufacturing, research, marketing, etc. But, lack or inadequacy of resources and time needed for internal development may constrain a company's pace of growth. Hence, a company can acquire production facilities as well as other resources from outside through mergers and acquisitions. Specially, for entering in new products/markets, the company may lack technical skills and may require special marketing skills and a wide distribution network to access different segments of markets. The company can acquire existing company or companies with requisite infrastructure and skills and grow quickly. Enhancing profitability because a combination of two or more companies may result in more than average profitability due to cost reduction and efficient utilization of resources. This may happen because of:Economies of scale:- arise when increase in the volume of production leads to a reduction in the cost of production per unit. This is because, with merger, fixed costs are distributed over a large volume of production causing the unit cost of production to decline. Economies of scale may also arise from other indivisibilities such as production facilities, management functions and management resources and systems. This is because a given function, facility or resource is utilized for a large scale of operations by the combined firm. Operating economies:- arise because, a combination of two or more firms may result in cost reduction due to operating economies. In other words, a combined firm may avoid or reduce over-lapping functions and consolidate its management functions such as manufacturing, marketing, R&D and thus reduce operating costs. For example, a combined firm may eliminate duplicate channels of distribution, or crate a centralized training center, or introduce an integrated planning and control system. Synergy:- implies a situation where the combined firm is more valuable than the sum of the individual combining firms. It refers to benefits other than those related to economies of scale. Operating economies are one form of synergy benefits. But apart from operating economies, synergy may also arise from enhanced managerial capabilities, creativity, innovativeness, R&D and market coverage capacity due to the complementarity of resources and skills and a widened horizon of opportunities.

Net Worth
Definition 1

For a company, total assets minus total liabilities. Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation. Net worth can be used to determine creditworthiness because it gives a snapshot of the company's investment history. also called owner's equity, shareholders' equity, or net assets. Definition 2 For an individual, the value of a person's assets, including cash, minus all liabilities. The amount by which the individual's assets exceed their liabilities is considered the net worth of that person. Advantages of Mergers & Acquisitions Diversifying the risks of the company particularly when it acquires those businesses whose income streams are not correlated. Diversification implies growth through the combination of firms in unrelated businesses. It results in reduction of total risks through substantial reduction of cyclicality of operations. The combination of management and other systems strengthen the capacity of the combined firm to withstand the severity of the unforeseen economic factors which could otherwise endanger the survival of the individual companies. Advantages of Mergers & Acquisitions A merger may result in financial synergy and benefits for the firm in many ways:By eliminating financial constraints By enhancing debt capacity. This is because a merger of two companies can bring stability of cash flows which in turn reduces the risk of insolvency and enhances the capacity of the new entity to service a larger amount of debt By lowering the financial costs. This is because due to financial stability, the merged firm is able to borrow at a lower rate of interest. Advantages of Mergers & Acquisitions Limiting the severity of competition by increasing the company's market power . A merger can increase the market share of the merged firm. This improves the profitability of the firm due to economies of scale. The bargaining power of the firm vis--vis labour, suppliers and buyers is also enhanced. The merged firm can exploit technological breakthroughs against obsolescence and price wars. Procedure for evaluating the decision for mergers and acquisitions Planning:- of acquisition will require the analysis of industry-specific and firmspecific information. The acquiring firm should review its objective of acquisition in the context of its strengths and weaknesses and corporate goals. It will need industry data on

market growth, nature of competition, ease of entry, capital and labour intensity, degree of regulation, etc. This will help in indicating the product-market strategies that are appropriate for the company. It will also help the firm in identifying the business units that should be dropped or added. On the other hand, the target firm will need information about quality of management, market share and size, capital structure, profitability, production and marketing capabilities, etc. Search and Screening:- Search focuses on how and where to look for suitable candidates for acquisition. Screening process short-lists a few candidates from many available and obtains detailed information about each of them. Financial Evaluation:- of a merger is needed to determine the earnings and cash flows, areas of risk, the maximum price payable to the target company and the best way to finance the merger. In a competitive market situation, the current market value is the correct and fair value of the share of the target firm. The target firm will not accept any offer below the current market value of its share. The target firm may, in fact, expect the offer price to be more than the current market value of its share since it may expect that merger benefits will accrue to the acquiring firm.

Due Diligence
Generally, the information that an acquirer expects is broken down into the following categories: General Corporate Matters , Financial, Accounting, and Taxes , Technology and Intellectual Property Product / Service Offerings Operations Sales and Marketing Human Resources and Personnel Legal and Regulatory Within each category, there tend to be two distinct types of requests: document requests and questions to be answered over the phone and in meetings. Often, it possible that there will be a priority due diligence checklist early in the process and a more detailed one later. Also, a savvy acquirer will want to see projections, reports, and other documents actually used by the company, as opposed to specially-created projections and reports just for the M&A process. Ultimately, anything that could be material enough to affect the valuation of the business is fair game. Since the potential acquirer doesnt know what is material until it asks, the initial due diligence list can be overly long, with a number of requests that are irrelevant.

Key issues governing due diligence ( investigation)

Assessing the quality of earnings , Identifying key business drivers and operating result trends ,Analyzing key balance sheet components and valuation issues, for example, identifying overvalued assets and undervalued liabilities , Analyzing working capital sensitivity and seasonality relative to proposed target levels ,Quantifying tax exposures Considering areas of non-financial due diligence such as: Operations and technology due diligence , HR due diligence ,Coordinating with other advisors/investors (e.g., legal, lenders) , Supporting the buyer's negotiating position and purchase price adjustments , Providing input to purchase and debt agreements and other related documents

Key Steps
Pre-Acquisition Due Diligence Identification of hidden and potential liabilities and cash-flow implications, as well as major gaps in the target company's current insurance and employee benefits programs including pension fund valuation and transfer Integration Assistance with the identification of the skills and resources needed to ensure a smooth integration Pre-Closing Design of post-completion insurance and benefits programme before the transaction date to take advantage of enhanced coverage and competitive pricing Post-Closing Ensuring the recommendations highlighted in the due diligence reports are implemented Due diligence consists of four distinct steps Signing the confidentiality agreement a launching pad for the due diligence process

Creating and delivering the due diligence request

Establish formal ground rules Determine exceptions Re ensure confidentiality Prioritizing , Detailing Documenting

Handling the information exchange

Evaluating the information provided

Timeliness Thoroughness Team composition Executive involvement Friendly cooperation with target Strategic foresight

Valuation methodologies
method that provides an appropriate value in every case as each target Since most M&A transactions are expected to deliver synergies, a discounted cash flow method is often used as it takes into account future benefits to the acquirer Valuation method would normally be supplemented with other valuation techniques to obtain an appropriate range of values for the target company Other No single universal valuation valuation techniques utilized may include an analysis of comparable transactions in a similar industry to obtain earnings or revenue multiples An asset valuation focused on replacement cost or perhaps a Greenfield analysis which would assess the cost to start from scratch a business similar to the target Financial due diligence key driver to valuation basis Key focus of financial due diligence, for the buyer and by implication the seller, is to identify issues which will have a direct impact on the valuation drivers and therefore, the valuation of the target company. For example, should the pricing agreed with the seller is based on a discounted cash flow model, then the financial due diligence should assess the assumptions used in the target's projected cash flows and identify key risk areas and appropriate adjustments in light of historical performance. If the pricing is to be determined using an earnings multiple, then the financial due diligence should seek to identify adjustments to the target's reported earnings to arrive at sustainable earnings against which the earnings multiple would be applied. In both examples, financial due diligence seeks to validate the underlying valuation assumptions of the target and therefore has a direct impact on the valuation.

Post due diligence process

Post due
Integration checklist

Competitive advantage of M&A

1.Unmatched scale and scope 2.High margin, low cost producer 3.Unmatched R & D capabilities 4.Geographic and product diversity 5.Integrated business model 6.Strong financial profile uniquely positioned for growth7.Synergies in the management team and the knowledge management

Market entry strategies

Factors affecting Entry Mode Modes Of Entry,Exporting,Licensing,Joint ventures,Manufacturing,Assembly operations,Management contract,Turnkey operations,Acquisition,Strategic Alliances,Greenfield Versus Cross Border Acquisition

Manufacturing
Manufacturing refers to setting up a production base inside a target country and can take the form of complete manufacturing , contract manufacturing and partial manufacturing. Why do host countries try to persuade companies to set up manufacturing bases ? Creation of jobs FDI brings in resources like technology, management expertise Access to export markets Manufacturing Advantages to MNC Gaining access to raw materials or to take advantage of resources for its manufacturing operations Take advantage of lower labour costs or other factors of production Can make the product more competitive because the companies can avoid import duties and other trade barriers Reduces transportation costs. Manufacturing Disadvantages The selection of the country is a difficult process ,The advantage of labour costs can be neutralised by low productivity, Product image, Assembly Operations ,Parts of components are produced in various countries to gain each countries comparative advantage

Assembly Operations
Advantages

 Capital intensive parts may be produced in advanced nations and labour intensive parts may be produced in less developed countries where labour is cheap and abundant. Allows companies to be price competitive against cheap imports. Allows a companys products to enter many markets without being subject to tariffs or quotas. : Assembly Operations Disadvantage Laws on local content may differ from country to country and if the countries insist on higher and higher local content, the price advantage may be lost.

Management Contract
When a foreign company signs a management contract with a government or with a private enterprise , it actually manages the business for a new owner as the new owner may lack technical and managerial expertise. Management contracts could be a sound strategy to enter a foreign market with a minimum investment and minimum political risk.

Turnkey Operations
A turnkey operation is an agreement by the seller to supply the buyer with a facility fully equipped and ready to be operated by the buyers personnel , who will be trained by the seller. In international marketing, the term is usually associated with giant projects that are sold to the government or government run companies. Turnkey Operations Advantage of turnkey operations is the rich rewards it brings with it . Disadvantage is that companies sometimes have to arrange for huge financing for their projects.

Acquisitions
Used as a rapid entry strategy in foreign markets with the objective of retaining maximum control. Foreign companies are usually acquired for reasons of Geographic diversification Product diversification

 Acquisition of expertise like technology, management etc.

Acquisitions
Disadvantages Acquisition displaces and replaces domestic ownership and is perceived as a blow to national pride. Involves legal hurdles Involves protection / hedging against currency fluctuations contd. Acquisitions Acquisition is a complex process involving finding a suitable company, determining a fair price, managing cross cultural teams, geographic distance, organising funds etc.

Strategic Alliances
Strategic alliances may be the result of mergers, acquisitions , joint ventures, licensing etc. and is a kind of corporate cooperation. Motive behind strategic alliances can be To access new markets, Accelerating pace of entry, A more complete product line, Learning new skills, Strategic Alliances, Strategic Alliances may not be an equity based investment but more of a contractual agreement whereby two or more partners agree to cooperate with each other and utilise each partners resources and expertise to achieve rapid global penetration. Strategic Alliances can take the form of Shared Distribution eg. Chryslers distribution of Mitsubishi cars in the USA Licensed manufacturing eg.Matsushitas manufacturing IBM PCs enabling the partners to utilise unused capacity R&D Alliances Phillips and Sony to counter Toshiba in developing digital videodisks.

Licensing Licensing is an agreement that permits a foreign company to use industrial property

( ie patents, trademarks, copyrights) , technical know how and skills ( ie feasibility studies, manuals, technical advise) , architectural or engineering designs or any other combination of these in a foreign market . Essentially, a licensor allows a foreign company to manufacture a product for sale in the licensees country and sometimes in other specified markets. Advantages A companys R&D and investment costs can be spread while enabling it to receive income from overseas at a negligible expense Can help overcome trade barriers and also help when import restrictions discourage direct entry. Quick and easy way to enter the market An owner of a valuable brand can benefit immensely from licensing Works well when transportation cost is high especially relative to the product value. Disadvantages May not be a good long-term strategy as a future competitor who is gaining technical and product knowledge is being developed It is difficult to prevent the licensee from using the process learned and acquired while working under license If the licensee performs poorly, it is difficult to enter directly as the agreements can prevent the licensor from doing so. Can lead to inconsistent product quality across countries if quality control is not strict Psychologically, many imported products enjoy a certain degree of prestige which can rapidly disappear when the product is made under local licenses. Licensing Ideally, licensing terms should cover Product and territorial coverage Quality Control Royalty rate and structure Choice of currency Specify the conditions under which a trademark can or cannot be used by the licensee.

 FDI FDI = purchase / control of a company in a country by residents of another country MNCs. Note, it refers equally to take-overs as well as to new investment even JOINT VENTURE. WHAT IS A JOINT VENTURE? A joint venture is a legal organization that takes the form of a short term partnership in which the persons jointly undertake a transaction for mutual profit. Generally each person contributes assets and share risks. The venture can be for one specific project only, or a continuing business relationship such as the Sony Ericsson joint venture. An enterprise formed for a specific business purpose by two or more investors sharing ownership and control. Company resources, circumstances and the reasons for wanting to do business overseas determine if a joint venture is the most reasonable way to enter overseas markets. Joint Venture Joint ventures reduce the amount of resources that each partner must contribute Sometimes joint ventures are the only way that a company can enter a market ( when wholly owned activities are prohibited in a country) MNCs have used it effectively in the past to enter countries like Russia and China Cont. .. Alternate modes of entry REASONS TO FORM A JOINT VENTURE Internal Goals Spreading costs and risks, Improving access to financial resources, Economies of scale and advantages of size , Access to new technologies and customers , Access to innovative managerial practices Competitive goals Influencing structural evolution of the industry , Pre-empting competition , Defensive response to blurring industry boundaries , Creation of stronger competitive units , Speed to market , Improved agility Strategic goals

 Synergies , Transfer of technology/skills , Diversification, Negotiation Problems, Negotiation Agreement, Valuation Problems, Transparency, Conflict Resolution, Division of Management Responsibility and Degree of Management Independence, Changes in Ownership Shares, Dividend Policy and Other Financial Matters, Marketing and Staffing Issues, Operational Problems Problems Relating to Multinationality Export Rights, Tax Issues, Dividend and Investment Policies, Differences in Partner Size Ownership and Control Problems Product Line Disputes, Material and Component Sourcing, Technology Utilization, Cultural Problems Changing Relationship