What is a 'Merger'

A merger is a deal to unite two existing companies into one new company. There are several
types of mergers and also several reasons why companies complete mergers. Most mergers
unite two existing companies into one newly named company. Mergers and acquisitions are
commonly done to expand a companys reach, expand into new segments, or gain market share.
All of these are done to please shareholders and create value.

In 2015, there was a record $4.30 trillion worth of mergers and acquisitions announced. Deal
making continues to be a popular way to grow revenue and earnings for companies of varying
size. Mergers are most commonly done to gain market share, expand to new territories, and
unite common products.

Types of Mergers

There are five main types of company mergers:

Conglomerate: nothing in common for united companies

Horizontal: both companies are in same industry, deal is part of consolidation

Market Extension: companies sell same products but compete in different markets

Product Extension: add together products that go well together

Vertical Merger: two companies that make parts for a finished good combine

Examples of Mergers

Anheuser-Busch InBev is an example of how mergers work and unite companies together. The
company is the result of multiple mergers,consolidation, and market extensions in the beer
market. The newly named company is the result of the mergers of three large international
beverage companies. Anheuser-Busch InBev is the end result of uniting Interbrew (Belgium),
Ambev (Brazil), and Anheuser-Busch (United States). Ambev merged with Interbrew uniting the
number three and five largest brewers in the world. When Ambev and Anheuser-Busch merged,
it united the number one and two largest brewers in the world. This example represents
both horizontal merger and market extension as it was industry consolidation but also extended
the international reach of all the combined companys brands.

The largest mergers in history have totaled over $100 billion each. In 2000, Vodafone acquired
Mannesmann for $181 billion to create the worlds largest mobile telecommunications company.
In 2009, AOL and Time Warner merged in a $164 million deal that is considered one of the
biggest flops ever. In 2014, Verizon Communications bought out Vodafones 45% stake in
Vodafone Wireless for $130 billion.

Due to the large number of mergers, there is even a mutual fund that gives investors a chance to
profit from the deals. The fund captures the spread, or amount left between the offer price and
trading price. The Merger Fund from Westchester Capital Funds has been around since 1989. The
fund invests in companies that have publicly announced a merger or takeover. To invest in the
fund, a minimum amount of $2,000 is required, and the fund does charge a higher 1.7% expense
ratio. Since its inception, the fund has returned an average of 6.3% annually.

Types of merger

A conglomerate merger is a merger between firms that are involved in totally unrelated business
activities. There are two types of conglomerate mergers: pure and mixed. Pure conglomerate
mergers involve firms with nothing in common, while mixed conglomerate mergers involve firms
that are looking for product extensions or market extensions.

Conglomerate mergers happen when two companies that offer varying services or are involved
in different sectors of business merge together. This type of conglomerate merger can occur
when two similar companies are deciding to merge in order to spread themselves better
throughout the market. This ensures the two companies as one entity are a stronger company
than they would be on their own. When these types of deals occur, it can upset some of the
market, because it could allow a monopoly in a certain market. There are both advantages and
disadvantages to these types of mergers.

There are many reasons for firms to merge, which include increasing market share, synergy and
cross selling. Firms also merge to diversify and reduce their risk exposure. However, if a
conglomerate becomes too large as a result of acquisitions, the performance of the entire firm
can suffer. This occurred during the conglomerate merger phase of the 1960s.
A horizontal merger is a merger or business consolidation that occurs between firms that operate
in the same space, as competition tends to be higher and the synergies and potential gains in
market share are much greater for merging firms in such an industry. This type of merger occurs
frequently because of larger companies attempting to create more efficient economies of scale,
such as the amalgamation of Daimler-Benz and Chrysler. Conversely, a vertical merger takes
place when firms from different parts of the supply chain consolidate to make the production
process more efficient or cost effective.

Horizontal mergers help companies gain advantages over competitors. For example, if one
company sells products similar to the other, the combined sales of a horizontal merger give the
new company a greater share of the market. If one company manufactures products
complementary to the other, the newly merged company may offer a wider range of products to
customers. Merging with a company offering different products to a different sector of the
marketplace helps the new company diversify its offerings and enter new markets.

A vertical merger is a merger between two companies that operate at separate stages of the
production process for a specific finished product. A vertical merger occurs when two or more
firms, operating at different levels within an industry's supply chain, merge operations. Most
often, the logic behind the merger is to increase synergiescreated by merging firms that would
be more efficient operating as one.

A vertical merger, also known as a vertical integration, is a merger between a manufacturer and a
supplier within the same industry. These types of mergers or integrations occur when a company
seeks to reduce operating costs and increase efficiency to realize higher profits. Combining the
operations of two companies allows a parent company to control the entire production cycle of a
product by incorporating two businesses as a single business entity.

Merger and Acquisition in India

Mergers and acquisitions (M&A) refers to the aspect of corporate strategy, corporate finance and

management dealing with the buying, selling and combining of different companies that can aid,
finance, or help a growing company in a given industry grow rapidly without having to create

another business entity.

An acquisition, also known as a takeover or a buyout, is the buying of one company (the target)

by another.

The acquisition process is very complex and various studies shows that only 50% acquisitions are

successful.

An acquisition may be friendly or hostile. In a friendly takeover a companies cooperate in

negotiations. In the hostile takeover, the takeover target is unwilling to be bought or the target's

board has no prior knowledge of the offer.

Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a

smaller firm will acquire management control of a larger or longer established company and

keep its name for the combined entity. This is known as a reverse takeover.

Although merger and amalgamation mean the same, there is a small difference between the two.

In a merger one company acquires the other company and the other company ceases to exist. In

an amalgamation, two or more companies come together and form a new business entity.

Governing Law:

The Companies Act, 1956 does not define the term 'Merger' or 'Amalgamation'. It deals with

schemes of merger/ acquisition which are given in s.390-394 'A', 395,396 and 396 'A'.
Classifications of mergers

Horizontal merger is the merger of two companies which are in produce of same products. This

can be again classified into Large Horizontal merger and small horizontal merger.

Horizontal merger helps to come over from the competition between two companies merging

together strengthens the company to compete with other companies. Horizontal merger

between the small companies would not effect the industry in large. But between the larger

companies will make an impact on the economy and gives them the monopoly over the market.

Horizontal mergers between the two small companies are common in India. When large

companies merging together we need to look into legislations which prohibit the monopoly.

Vertical merger is a merger between two companies producing different goods or services for

one specific finished product. Vertical merger takes between the customer and company or a

company and a supplier. IN this a manufacture may merge with the distributor or supplier of its

products. This makes other competitors difficult to access to an important componet of product

or to an important channel of distribution which are called as "vertical foreclosure" or

"bottleneck" problem.Vertical merger helps to avoid sales taxes and other marketing

expenditures.

Market-extension merger - is a merger of two companies that deal in same products in different

markets. Market extension merger helps the companies to have access to the bigger market and

bigger client base.

Product-extension merger takes place between the two or more companies which sells

different products but related to the same category. This type of merger enables the new

company to go in for a pooling in of their products so as to serve a common market, which was

earlier fragmented among them. This merger is between two companies that sell different, but

somewhat related products, in a common market. This allows the new, larger company to pool

their products and sell them with greater success to the already common market that the two

separate companies shared.

The product extension merger allows the merging companies to group together their products

and get access to a bigger set of consumers. This ensures that they earn higher profits.

Conglomeration - Two companies that have no common business areas. A conglomeration is the

merger of two companies that have no related products or markets. In short, they have no

common business ties.

Conglomerate merger in which merging firms are not competitors, but use common or

related productionprocesses and/or marketing and distribution channels.

Congeneric merger: Merger between firms in the same general industry but having

no mutual buyer-seller relationship, such as a merger between a bank and a leasing company.

A m e r g er i n which o n e f i r m a c qu i r es a n ot h e r fi r m t h at is in the s am e

g e n e r al in du st r y b u t n e i t h er i n t h e s a me l i n e o f bu s in e s s n o r a s u p p li e r or

c u s t om e r .
Purchase mergers - this kind of merger occurs when one company purchases another. The

purchase is made with cash or through the issue of some kind of debt instrument; the sale is

taxable.

Acquiring companies often prefer this type of merger because it can provide them with a tax

benefit. Acquired assets can be written-up to the actual purchase price, and the difference

between the book value and the purchase price of the assets can depreciate annually, reducing

taxes payable by the acquiring company.

Consolidation mergers - With this merger, a brand new company is formed and both companies

are bought and combined under the new entity. The tax terms are the same as those of a

purchase merger.

A unique type of merger called a reverse merger is used as a way of going public without the

expense and time required by an IPO.

Accretive mergers are those in which an acquiring company's earnings per share (EPS) increase.

An alternative way of calculating this is if a company with a high price to earnings ratio (P/E)

acquires one with a low P/E.

Dilutive mergers are the opposite of above, whereby a company's EPS decreases. The company

will be one with a low P/E acquiring one with a high P/E.

Merger and Acquisition Procedures:

1. Memorandum Of Association (M/A):-The Memorandum of Association must provide the power

to amalgamate in its objects clause. It M/A is silent, amendment in M/A must take place.
2. Board Meeting:-A Board Meeting shall be convened to consider and pass the following

requisite resolutions:

- approve the draft scheme of amalgamation;

- to authorize filing of application to the court for directions to convene a general meeting;

- to file a petition for confirmation of scheme by the High Court.

Through an application under s.391/ 394 of Companies Act, 1956 can be made by the member

or creditor of a company, the court may not be able to sanction the scheme which is not

approved by the company by a Board or members resolution.

Directors who are given the necessary powers by the AoA may present a petition on behalf of

the company without first obtaining the approval of the company in general meeting.

3. Application to the Court:- An application shall be made to the court for directions to convene

a general meeting by way of Judge's summons(Form No. 33) supported by an affidavit(Form

No. 34). The proposed scheme of amalgamation must be attached to such affidavit..

The summons should be accompanied by:

-A certified copy of the M&A of both companies

-A certified true copy of the latest audited B/S and P&L A/c of transferee company
The application to convene meeting under s.391(1) is required to be made to the respective

jurisdictional HC by the company concerned depending on the location of its registered office.

Similarly an application for the scheme of arrangement will have to be made to the concerned

HC where the companys registered office is situated.

Person entitled to apply:-

(i) U/s.391 & 394, members of the company have right to apply to court

(ii) A successor to a share of a deceased member has in the normal course, locus standi to

maintain an application u/s.391, 395.

(iii) An application can also be made by the transferee of shares.

(iv)The creditor also have right to apply to court.

(v) The liquidator is also empowered to make an application to the court.

4. Copy to Regional Director:-A copy of application made to concerned H.C. shall also be sent to

the R.D. of the region. Although, such notice is supposed to be sent by the H.C., usually the

company sends it without waiting for the H.C. to send it.

5. Order Of High Court(Orders in - Form No. 35):-On hearing of the summons, the H.C. shall pass

the necessary orders which shall include:

(a) Time and place of the meeting,

(b) Chairman of the meeting,

(c) Fixing the quorum,

(d) Procedure to be followed in the meeting for voting by the proxy,

(e) Advertisement of notice of the meeting,

(f) Time limit for the chairman to submit the report to the court regarding the result of the

meeting.

Where the court observes that any of the following circumstances exist in the case of the merger

it may not order a meeting when shareholders are few in number; or where the membership is

restricted to a single family, HUF or close relatives; or where shareholding pattern of transferor

and transferee companies is identical.

6. Notice Of The Meeting(Notice in - Form No. 36):-The notice of the meeting shall be sent to

the creditors and/or all the shareholders individually (including preference shareholders) by the

chairman so appointed by registered post enclosing: (a) A statement setting forth the following:

- Terms of amalgamation and its effects

- Any material interests of the director, MDs or Manager, in any capacity

- Effect of the arrangement on those interests.

(b) A copy of the proposed scheme of amalgamation

(c) A form of proxy,( Proxy in - Form No. 37)

(d) Attendance slip,

(e) Notice of the resolution for authorizing issue of shares to persons other than existing

shareholders

Computation: The notice that is required to be given u/s.393 of the Act for the meeting of the

members/creditors shall be by 21 clear days notice.

7. Advertisement of Notice Of Meeting(Advertisement in - Form No. 38):-The notice of the

meeting shall be advertised in an English and Hindi Newspapers as the court may direct by

giving not less than 21 clear days notice before the date fixed for the meeting. However in some

instances, the 21 days period can be condoned if reasons are found jusiticiable.

8. Notice To Stock Exchange:- In case of the listed company, 3 copies of the notice of the

general meeting along with enclosures shall be sent to the Stock Exchange where the company

is listed.

9. Filing Of Affidavit For The Compliance:- An affidavit not les than 7 days before the meeting

shall be filed by the Chairman of the meeting with the Court showing that the directions

regarding the issue of notices and advertisement have been duly complied with.

10. General Meeting:-The General Meeting shall be held to pass the following resolutions:

(a) Approving the scheme of amalgamation by th majority e.g. if a meeting is attended by say

100 members holding 100 shares, the scheme shall be deemed to have been approved only when

it is supported by atleast 51 members holding together 750 shares amounts themselves;

(b) Special Resolution authorizing allotment of shares to persons other than existing shareholders

or an ordinary resolution be passed subject to getting Central Government's approval for the

allotment as per the provisions of Section 81(1A) of the Companies Act, 1956,

(c) The resolution to empower directors to dispose of the shares not taken up by the dissenting

shareholders at their discretion.,

(d) An ordinary/special resolution shall be passed to increase the Authorized share capital, if the

proposed issue of shares exceeds the present authorized capital. The decision of the meeting

shall be ascertained only by taking a poll on resolutions.

In case of Transfer company need not to pass a special resolution for offering shares to the

persons other than the existing shareholders.

11. Reporting of Result of the Meeting(Report in - Form No. 39):-The Chairman of the meeting

shall report the result of the meeting to the court within the time fixed by the judge or within 7

days, as the case may be. A copy of proceedings of the meeting shall also be sent to the

concerned Stock Exchange.

12. Formalities With ROC:- The following documents shall be filed with ROC along-with the

requisite filing fees:

(i)Form No. 23 of Companies General Rules & Forms + copy of Special Resolution, (there is no

need for the transferor company to file Form No. 23 of the Companies General Rules and Forms

with the Registrar of Companies.)

(ii)Resolution approving the scheme of amalgamation,

(iii) Special resolution passed for the issue of shares to persons other than existing shareholders.

13. Petition (Petition in - Form No. 40):-For approval of the scheme of amalgamation, a petition

shall be made to the H.C. within 7 days of the filing of report by the chairman.

If the Regd. Offices of the companies are in same state - then both the companies may move

jointly to the High Court.

If the Regd. Offices of the companies are in different states - then each company shall move the

petition in respective High Court for directions.

However in a recent judgment of Jaipur Polypin Ltd. v. Rajasthan Spinning & Weaving Mills, it

was held that when the two companies are at different places, then no need to file an application

at two different places.

14. Sanction of The Scheme:- The Court shall sanction the scheme on being satisfied that: (i) The

whole scheme is annexed to the notice for convening meeting. (This provision is mandatory in

nature)

(ii) The scheme should have been approved by the company by means of th majority of the

members present.

(iii)The scheme should be genuine and bona fide and should not be against the interests of the

creditors, the company and the public interest.

After satisfying itself, the court shall pass orders in the requisite form(Orders in - Form No. 41).
The requirement of law is permission or approval of court to the scheme.

The application made by the company is to seek courts approval to the company scheme of

amalgamation and not merely ordering a meeting. The court may order a meeting of members

too.

The court must consider all aspects of the matter so as to arrive at a finding that the scheme is

fair, just and reasonable and does not contravene public policy or any statutory provision.

While interpreting s.394 r/w s.391, we find that the Tribunals power of ordering

amalgamation/reconstruction is limited by two provisos of s.394: Firstly, Tribunal has to await the

receipt of report from the Registrar of Companies about the manner in which affairs of the

Company are conducted. Secondly, when the transferor company is proposed to be dissolved

without winding up, the Tribunal shall await.

15. Stamp Duty :A scheme sanctioned by the court is an instrument liable to stamp duty.

16. Filing with ROC: The following documents shall be filed with ROC within 30 days of order:

-A certified true copy of Court's Order

-Form No. 21 of Companies General Rules & Forms

17. Copy of Order to be annexed: A copy of court's order shall be annexed to every copy of the

Memorandum of Association issued after the certified copy of the order has been filed with as

aforesaid.
18. Allotment of shares: A Board Resolution shall be passed for the allotment of shares to the

shareholders in exchange of shares held in the transferor-company and to fix the record date for

this purpose.

Mergers and Acquisitions: Valuation

In a merger or acquisition transaction, valuation is essentially the price that one party will pay for
the other, or the value that one side will give up to make the transaction work. Valuations can be
made via appraisals or the price of the firms stock if it is a public company, but at the end of the
day valuation is often a negotiated number.

Valuation is often a combination of cash flow and the time value of money. A businesss worth is
in part a function of the profits and cash flow it can generate. As with many financial transactions,
the time value of money is also a factor. How much is the buyer willing to pay and at what rate of
interest should they discount the other firms future cash flows?

Both sides in an M&A deal will have different ideas about the worth of a target company: its
seller will tend to value the company at as high of a price as possible, while the buyer will try to
get the lowest price that he can.

There are, however, many legitimate ways to value companies. The most common method is to
look at comparable companies in an industry, but deal makers employ a variety of other
methods and tools when assessing a target company. Here are just a few of them:

1. Discounted Cash Flow (DCF) - A key valuation tool in M&A, discounted cash flow analysis
determines a company's current value according to its estimated future cash flows. Forecasted
free cash flows (net income + depreciation/amortization - capital expenditures - change in
working capital) are discounted to a present value using the company's weighted average costs
of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival this valuation
method.

2. Comparative Ratios - The following are two examples of the many comparative metrics on
which acquiring companies may base their offers:
 Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes
an offer that is a multiple of the earnings of the target company. Looking at the P/E for all
the stocks within the same industry group will give the acquiring company good guidance
for what the target's P/E multiple should be.
Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company makes
an offer as a multiple of the revenues, again, while being aware of the price-to-sales
ratio of other companies in the industry.

3. Replacement Cost - In a few cases, acquisitions are based on the cost of replacing the target
company. For simplicity's sake, suppose the value of a company is simply the sum of all its
equipment and staffing costs. The acquiring company can literally order the target to sell at that
price, or it will create a competitor for the same cost. Naturally, it takes a long time to assemble
good management, acquire property and get the right equipment. This method of establishing a
price certainly wouldn't make much sense in a service industry where the key assets - people and
ideas - are hard to value and develop.

Some factors to consider in any analysis include:

Future prospects of the business. Does the target company have solid growth prospects
or at least generate solid profits and cash flow?
The risk of the other company? Are they in an industry that will add too much risk to the
combined entity? Operationally is the business well-run, is there a solid employee base?
The cost of capital in terms of this transaction providing the best return on the acquiring
partys capital.

What to Look For

It's hard for investors to know when a deal is worthwhile. The burden of proof should fall on the
acquiring company. To find mergers that have a chance of success, investors should start by
looking for some of these simple criteria:

Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes
an offer that is a multiple of the earnings of the target company. Looking at the P/E for all
the stocks within the same industry group will give the acquiring company good guidance
for what the target's P/E multiple should be.
 Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company makes
an offer as a multiple of the revenues, again, while being aware of the price-to-sales
ratio of other companies in the industry.

Financial impact of merger

A corporate merger or acquisition can have a profound effect on a companys growth prospects
and long-term outlook. But while an acquisition can transform the acquiring company literally
overnight, there is a significant degree of risk involved, as mergers and acquisitions
(M&A) transactions overall are estimated to only have a 50% chance of success. In the sections
below, we discuss why companies undertake M&A transactions, the reasons for their failures, and
present some examples of well-known M&A transactions.

Why do companies engage in M&A?

Some of the most common reasons for companies to engage in mergers and acquisitions
include

Become bigger: Many companies use M&A to grow in size and leapfrog their rivals. While
it can take years or decades to double the size of a company through organic growth,
this can be achieved much more rapidly through mergers or acquisitions.
Pre-empt competition: This is a very powerful motivation for mergers and acquisitions,
and is the primary reason why M&A activity occurs in distinct cycles. The urge to snap up
a company with an attractive portfolio of assets before a rival does so generally results in
a feeding frenzy in hot markets. Some examples of frenetic M&A activity in specific
sectors include dot-coms and telecoms in the late 1990s, commodity and energy
producers in 2006-07, and biotechnology companies in 2012-14.
Synergies and economies of scale: Companies also merge to take advantage
of synergies and economies of scale. Synergies occur when two companies with similar
businesses combine, as they can then consolidate (or eliminate) duplicate resources like
branch and regional offices, manufacturing facilities, research projects etc. Every million
dollars or fraction thereof thus saved goes straight to the bottom line, boosting earnings
per share and making the M&A transaction an accretive one.
 Achieve domination : Companies also engage in M&A to dominate their sector. However,
since a combination of two behemoths would result in a potential monopoly, such a
transaction would have to run the gauntlet of intense scrutiny from anti-competition
watchdogs and regulatory authorities.
Tax purposes: Companies also use M&A for tax purposes, although this may be an
implicit rather than an explicit motive. For instance, since the U.S. has the
highest corporate tax rate in the world, some of the best-known American companies
have resorted to corporate inversions. This technique involves a U.S. company buying a
smaller foreign competitor and moving the merged entitys tax home overseas to a
lower-tax jurisdiction, in order to substantially reduce its tax bill.

Why do mergers and acquisitions fail?

Some of the main risks that may precipitate the failure of an M&A transaction are

Integration risk: In many cases, integrating the operations of two companies proves to be
a much more difficult task in practice than it seemed in theory. This may result in the
combined company being unable to reach the desired targets in terms of cost-savings
from synergies and economies of scale. A potentially accretive transaction could therefore
well turn out to be dilutive.
Overpayment: If company A is unduly bullish about company Bs prospects and wants
to forestall a possible bid for B from a rival it may offer a very substantial premium for B.
Once it has acquired company B, the best-case scenario that A had anticipated may fail to
materialize. For instance, a key drug being developed by B may turn out to have
unexpectedly severe side-effects, significantly curtailing its market potential. Company As
management (and shareholders) may then be left to rue the fact that it paid much more
for B than what it was worth. Such overpayment can be a major drag on future financial
performance.
Culture Clash: M&A transactions sometimes fail because the corporate cultures of the
potential partners are so dissimilar. Think of a staid technology stalwart acquiring a
hot social media start-up and you may get the picture.

M&A Effects Capital Structure and Financial Position

M&A activity obviously has longer-term ramifications for the acquiring company or the dominant
entity in a merger, than it does for the target company in an acquisition or the firm that is
subsumed in a merger.

(Further Reading: How to profit from M&A through arbitrage.)

For the target company, an M&A transaction gives its shareholders the opportunity to cash out at
a significant premium, especially if the transaction is an all-cash deal. If the acquirer pays partly in
cash and partly in its own stock, the target companys shareholders would hold a stake in the
acquirer, and thus have a vested interest in its long-term success.

For the acquirer, the impact of an M&A transaction depends on the deal size relative to the
companys size. The larger the potential target, the bigger the risk to the acquirer. A company
may be able to withstand the failure of a small-sized acquisition, but the failure of a huge
purchase may severely jeopardize its long-term success.

Once an M&A transaction has closed, the impact upon the acquirer would typically be significant
(again depending on the deal size). The acquirers capital structure will change, depending on
how the M&A deal was designed. An all-cash deal will substantially deplete the acquirers cash
holdings. But as many companies seldom have the cash hoard available to make full payment for
a target firm in cash, all-cash deals are often financed through debt. While this additional debt
increases a companys indebtedness, the higher debt load may be justified by the additional cash
flows contributed by the target firm.

Many M&A transactions are also financed through the acquirers stock. For an acquirer to use its
stock as currency for an acquisition, its shares must often be premium-priced to begin with, else
making purchases would be needlessly dilutive. As well, management of the target company also
has to be convinced that accepting the acquirers stock rather than hard cash is a good idea.
Support from the target company for such an M&A transaction is much more likely to be
forthcoming if the acquirer is a Fortune 500 company than if it is ABC Widget Co.

M&A Effects Market Reaction and Future Growth

Market reaction to news of an M&A transaction may be favorable or unfavorable, depending on

the perception of market participants about the merits of the deal. In most cases, the target
companys shares will rise to a level close to that of the acquirers offer, assuming of course that
the offer represents a significant premium to the targets previous stock price. In fact, the targets
shares may trade above the offer price if the perception is either that the acquirer has lowballed
the offer for the target and may be forced to raise it, or that the target company is coveted
enough to attract a rival bid.

There are situations in which the target company may trade below the announced offer price.
This generally occurs when part of the purchase consideration is to be made in the acquirers
shares and the stock plummets when the deal is announced. For example, assume the purchase
price of $25 per share of TargetedXYZCo consists of two shares of an acquirer valued at $10 each
and $5 in cash. But if the acquirers shares are now only worth $8, TargetedXYZCo would most
likely be trading at $21 rather than $25.

There are any number of reasons why an acquirers shares may decline when it announces an
M&A deal. Perhaps market participants think that the price tag for the purchase is too steep. Or
the deal is perceived as not being accretive to EPS (earnings per share). Or perhaps investors
believe that the acquirer is taking on too much debt to finance the acquisition.

An acquirers future growth prospects and profitability should ideally be enhanced by the
acquisitions it makes. Since a series of acquisitions can mask deterioration in a companys core
business, analysts and investors often focus on the organic growth rate of revenue
and operating margins which excludes the impact of M&A for such a company.

In cases where the acquirer has made a hostile bid for a target company, the latters
management may recommend that its shareholders reject the deal. One of the most common
reasons cited for such rejection is that the targets management believes the acquirers offer
substantially undervalues it. But such rejection of an unsolicited offer can sometimes backfire, as
demonstrated by the famous Yahoo-Microsoft case.

On February 1, 2008, Microsoft unveiled a hostile offer for Yahoo Inc (YHOO) of $44.6 billion.
Microsoft Corps (MSFTMicrosoft CorpMSFT74.41+0.27%) offer of $31 per Yahoo share consisted
of one-half cash and one-half Microsoft shares, and represented a 62% premium to
Yahoos closing price on the previous day. However, Yahoos board of directors led by co-
founder Jerry Yang rejected Microsofts offer, saying that it substantially undervalued the
company. Unfortunately, the credit crisis that gripped the world later that year also took its toll
on Yahoo shares, resulting in the stock trading below $10 by November 2008. Yahoos
subsequent road to recovery was a long one, and the stock only exceeded Microsofts original
$31 offer five and a half years later in September 2013.

A few M&A examples

America Online Time Warner: In January 2000, America Online which had grown to
become the worlds biggest online service in just 15 years announced an audacious bid
to buy media giant Time Warner in an all-stock deal. AOL Inc. (AOL) shares had soared
800-fold since the companys IPO in 1992, giving it a market value of $165 billion at the
time it made its bid for Time Warner. However, things did not quite go the way that AOL
had expected as the Nasdaq commenced its two-year slide of almost 80% in March 2000,
and in January 2001, AOL became a unit of Time Warner. Time Warner Inc (time Warner
Inc102.40-0.09%) subsequently spun off AOL in November 2009 at a valuation of about
$3.4 billion, a fraction of AOLs market value in its heyday. The $186.2-billion original deal
between AOL and Time Warner remains the biggest M&A transaction to this day (as of
October 2014).

Gilead Sciences Pharmasset: In November 2011, Gilead Sciences (GILDGilead Sciences

IncGILD83.27+0.79%) the worlds largest maker of HIV medications announced an
$11-billion offer for Pharmasset, a developer of experimental treatments for hepatitis C.
Gilead offered $137 in cash for each Pharmasset share, a whopping 89% premium to its
previous closing price. The deal was perceived as a risky one for Gilead, and its shares fell
9% on the day it announced the Pharmasset deal. But few corporate gambles have paid
off as spectacularly as this one did. In December 2013, Gileads Sovaldi
received FDA approval for treating hepatitis C after it proved to be remarkably effective in
treating an affliction that affects 3.2 million Americans. While Sovaldis $84,000 price tag
for a 12-week course of treatment stirred some controversy, by October 2014, Gilead had
a market value of $159 billion a more than five-fold increase from $31 billion shortly
after it closed the Pharmasset purchase making it the worlds 36th-largest company
by market capitalization.

ABN Amro Royal Bank of Scotland: This GBP 71-billion (approx. $100-billion) deal was
remarkable in that it led to the near-demise of two of the three members of the buying
consortium. In 2007, Royal Bank of Scotland, Belgian-Dutch bank Fortis and Spains Banco
 Santander, won a bidding war with Barclays Bank for Dutch bank ABN Amro. But as the
global credit crisis began intensifying from the summer of 2007, the price paid by the
buyers of three times ABN Amros book value looked like sheer folly. RBS stock price
subsequently collapsed and the British government had to step in with a GBP 46-
billion bailout in 2008 to rescue it. Fortis was also nationalized by the Dutch government
in 2008 after it was on the brink of bankruptcy.

MERGER AND DILUTION EFFECT ON EPS

Accretion describes the positive change to a company's earnings per share
(EPS) after a merger or acquisition of another company. In these transactions,
the remaining company does not always gain, and the transaction may result in
diluted stock. Merger and acquisition analysts perform an accretion/dilution
analysis to determine the potential outcome of different business combination
scenarios. This serves as part of the decision-making process before an actual
transaction takes place.

Assemble a projected, pro forma income statement for the new, combined
company. A pro forma income statement factors in financial changes you expect
as a result of a merger or acquisition transaction. Include a conservative view of
the company's net income. Some analysts start with 12 months of historical data
and two years of projected data, while others use strictly projected data.

Factor expected synergies from the transaction into the projections. Examples
include increased revenues from new or complementary product lines or service
offerings. Also, factor in expectations of reduced cost benefits from the
elimination of any redundant manufacturing processes, buildings, personnel or
other company functions.

Factor in costs related to the company's transaction, such as increased interest

expense if debt was used to finance the deal. If a company uses its cash to
finance a deal, lower its future income from interest on cash investments. Add
the amortization expense that comes with the acquisition of intangible assets,
such as patents, copyrights, goodwill or trade names.

Calculate the number of shares for the new company. This number is dependent
on whether the transaction is a merger or acquisition, and whether the issuance
of new stock will finance any part of the transaction. The result should be a pro
forma stock shares outstanding estimate.
Divide the pro forma net income by the pro forma shares of stock. This becomes
the pro forma EPS estimate. Compare this to the EPS of the original company. If
the pro forma EPS is higher, analysts determine the transaction to be accretive.