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PPT Courtesy : CFA Institute

“Merger is an absorption of one or more companies by


a single existing company.”
MEANING OF MERGER
1. Acquiring company is a single existing company that
purchases the majority of equity shares of one or
more companies.

2. Acquired companies are those companies that


surrender the majority of their equity shares to an
acquiring company.
Introduction
• Mergers and acquisitions (M&A) are complex, involving
many parties.
• Mergers and acquisitions involve many issues, including
– Corporate governance.
– Form of payment.
– Legal issues.
– Contractual issues.
– Regulatory approval.
• M&A analysis requires the application of valuation tools
to evaluate the M&A decision.
TYPES OF MERGERS
1.Horizontal Merger
2.Vertical Merger
3.Conglomerate Merger
4.Marketing Extension Merger
5.Product Extension Merger
TYPES OF MERGERS
MERGER

Market-extension Product-extension Conglomerate


merger merger merger

Two companies that Two companies selling Two companies that


sell the same products different but related have no common
in different markets products in the same business areas
market
1.Horizontal merger

A horizontal merger occurs when two or more


firms in the same market, producing substitute
.products, join together to form a single firm. An
example of a horizontal merger is that of two
soft drink companies. The firms are competitors
producing similar products.
2.Vertical Merger

'Vertical Merger' A merger between two companies


producing different goods or services for one specific
finished product. A vertical merger occurs when two
or more firms, operating at different levels within an
industry's supply chain, merge operations.
3.Conglomerate Mergers

Conglomerate merger in which merging firms are not


competitors, but use common or related production
processes and/or marketing and distribution
channels.
4.Market Extension Merger
Market extension merger takes place between two
companies that deal in the same products but in
separate markets.
5.Product Extension Merger
Product extension merger takes place between two
business organizations that deal in products that are
related to each other and operate in the same market.
TRIVIAL FEW EXAMPLES OF LARGER MERGERS
Tata Steel-Corus: $12.2 billion
•January 30, 2007
•Largest Indian take-over
•After the deal TATA’S became
the 5th largest STEEL co.
•100 % stake in CORUS paying Rs
428/- per share

Image: B Mutharaman, Tata Steel MD; Ratan Tata,


Tata chairman; J Leng, Corus chair;
and P Varin, Corus CEO.
Vodafone-Hutchison Essar: $11.1 billion
•TELECOM sector
•11th February 2007
•2nd largest takeover
deal
•67 % stake holding in
hutch

Image: The then CEO of Vodafone Arun


Sarin visits Hutchison Telecommunications
head office in Mumbai.
Hindalco-Novelis: $6 billion
•June 2008
•Aluminium and copper
sector
•Hindalco Acquired Novelis
•Hindalco entered the
Fortune-500 listing of
world's largest companies
by sales revenues
Image: Kumar Mangalam Birla
(center), chairman of Aditya Birla
Group.
HDFC Bank-Centurion Bank of Punjab: $2.4 billion

•February, 2008
•Banking sector
•Acquisition deal
•CBoP shareholders got
one share of HDFC Bank
for every 29 shares held
by them.
Image: Rana Talwar (rear) Centurion •9,510 crore
Bank of Punjab chairman, Deepak
Parekh, HDFC Bank chairman
Tata Motors-Jaguar Land Rover: $2.3 billion

•March 2008 (just a year


after acquiring Corus)
•Automobile sector
•Acquisition deal
•Gave tuff competition to
M&M after signing the
deal with ford
Image: A Union flag flies behind a Jaguar
car emblem outside a dealership in
Manchester, England.
Suzlon-RePower: $1.7 billion
•May 2007
•Acquisition deal
•Energy sector
•Suzlon is now the largest
wind turbine maker in
Asia
•5th largest in the world.

Image: Tulsi Tanti, chairman &


M.D of Suzlon Energy Ltd.
MERGER BETWEEN AIR INDIA AND INDIAN AIRLINES
•The government of India on
1 march 2007 approved the
merger of Air India and Indian
airlines.
• Consequent to the above a
new company called National
Aviation Company of India
limited was incorporated
under the companies act
1956 on 30 march 2007 with
its registered office at New
Delhi.
• http://www.jagranjosh.com/articles/top-10-mergers-
and-acquisitions-of-2016-1483014451-1

• https://gadgetstouse.com/featured/india-mergers-
acquisitions-2017/62390
Ways of merger – A merger can take
place in following ways:

By purchasing of assets

 By purchase of common shares

 By exchanging of shares for assets

 By exchanging of shares for shares


By purchase of
assets

By purchase of
common shares

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By exchanging of
shares for assets

By exchanging of
shares for shares

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2. Mergers and acquisitions Definition
Merger with Consolidation Acquisition

Company
Company
A
X

Company Company
C X
Company
Company
B
Y

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Mergers and Acquisitions Definitions
• Parties to the acquisitions:
– The target company (or target) is the company being
acquired.
– The acquiring company (or acquirer) is the company
acquiring the target.
• Classified based on endorsement of parties’ management:
– A hostile takeover is when the target company’s board of
directors objects to a takeover offer.
– A friendly transaction is when the target company board
of directors endorses the merger or acquisition offer.

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Mergers and Acquisitions Definitions
Classified by the relatedness of business activities of
the parties to the combination:
Type Characteristic Example
Horizontal merger Companies are in the same Walt Disney Company buys
line of business, often Lucasfilm (October 2012).
competitors.
Vertical merger Companies are in the same Google acquired Motorola
line of production (e.g., Mobility Holdings (June
supplier–customer). 2012).
Conglomerate Companies are in unrelated Berkshire Hathaway
merger lines of business. acquires Lubrizol (2011).

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3. Motives for merger
• Synergy
• Growth
Creating Value • Increasing market power
• Acquiring unique capabilities or resources
• Unlocking hidden value

• Exploiting market imperfections


• Overcoming adverse government policy
Cross-Border
• Technology transfer
Mergers
• Product differentiation
• Following clients

• Diversification
• Bootstrapping earnings
Dubious Motives
• Managers’ personal incentives
• Tax considerations
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Motives Behind Mergers of The Company

• (i) Economies of Scale: This generally refers to a method in which


the average cost per unit is decreased through increased
production
(ii) Increased revenue /Increased Market Share: This motive
assumes that the company will be absorbing the major competitor
and thus increase its to set prices.
(iii) Cross selling: For example, a bank buying a stock broker could
then sell its banking products to the stock brokers customers, while
the broker can sign up the bank’ customers for brokerage account.
(iv) Corporate Synergy: Better use of complimentary resources. It
may take the form of revenue enhancement and cost savings.
(v) Taxes
• (vi) Geographical or other diversification
In other words, theories of merger…
• Efficiency Theories
1. Differential Efficiency Theory
2. Inefficient Management Theory
3. Operating Synergy
4. Pure Diversification
5. Strategic Realignment to changing environment
6. Undervaluation
7. Overvaluation
8. Agency problem
9. Free Cash Flow Hypothesis
10. Market Power Hypothesis
11. Information Hypothesis
12. Bankruptcy Avoidance Hypothesis
13. Accounting and Tax Effects
Example: Bootstrapping earnings
Bootstrapping earnings is the increase in earnings per share as a result of a merger,
combined with the market’s use of the pre-merger P/E to value post-merger EPS.
Assumptions:
• Exchange ratio: One share of Company One for two shares of Company Two
• Market applies pre-merger P/E of Company One to post-merger earnings.

Company One
Company One Company Two Post-Acquisition
Earnings $100 million $50 million $150 million
Number of shares 100 million 50 million 125 million
Earnings per share $1 $1 $1.20
P/E 20 10 20
Price per share $20 $10 $24
Market value of stock $2,000 million $500 million $3,000 million

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Example: Bootstrapping earnings
$100 $50
Weighted PΤE = × 20 + × 10 = 16.67
$150 $150

Assumptions:
• Exchange ratio: One share of Company One for two shares of Company Two
• Market applies weighted average P/E to the post-merger company.
Company One
Company One Company Two Post-Acquisition
Earnings $100 million $50 million $150 million
Number of shares 100 million 50 million 125 million
Earnings per share $1 $1 $1.20
P/E 20 10 16.67
Price per share $20 $10 $20
Market value of stock $2,000 million $500 million $2,500 million

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4. Transaction characteristics
Form of the • Stock purchase
Transaction • Asset purchase

• Cash
Method of
• Securities
Payment
• Combination of cash and securities

Attitude of • Hostile
Management • Friendly

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Form of an Acquisition
• In a stock purchase, the acquirer provides cash, stock, or
combination of cash and stock in exchange for the stock
of the target firm.
– A stock purchase needs shareholder approval.
– Target shareholders are taxed on any gain.
– Acquirer assumes target’s liabilities.
• In an asset purchase, the acquirer buys the assets of the
target firm, paying the target firm directly.
– An asset purchase may not need shareholder
approval.
– Acquirer likely avoids assumption of liabilities.
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Method of Payment
• Cash offering Merger Transactions, 2005
– Cash offering may be cash from
existing acquirer balances or from a
debt issue. Cash only
• Securities offering
– Target shareholders receive shares Stock only
of common stock, preferred stock,
or debt of the acquirer. Cash and
– The exchange ratio determines the securities
number of securities received in Other
exchange for a share of target stock. securities
• Factors influencing method of payment:
– Sharing of risk among the acquirer
and target shareholders.
– Signaling by the acquiring firm.
– Capital structure of the acquiring
firm. Based on data from Mergerstat Review, 2006. FactSet
Mergerstat, LLC (www.mergerstat.com).

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Mindset of Managers
Friendly merger: Offer made through the Hostile merger: Offer made directly to
target’s board of directors the target shareholders

Types
Approach target management.
• Bear hug
• Tender offer
• Proxy fight
Enter into merger discussions.

Perform due diligence.

Enter into a definitive merger agreement.

Shareholders and regulators approve.

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Hostile vs. Friendly mergers
• The classification of a merger as friendly or hostile is
from the perspective of the board of directors of the
target company.
• A friendly merger is one in which the board
negotiates and accepts an offer.
• A hostile merger is one in which the board of the
target firm attempts to prevent the merger offer
from being successful.

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6. Regulation
• Section 390 to 395 of Companies Act, 1956 deal
with arrangements, amalgamations, mergers
and the procedure to be followed for getting the
arrangement, compromise or the scheme of
amalgamation approved.

• Antitrust law,
• Securities law

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7. Merger analysis
• The discounted cash flow (DCF) method is often used in the
valuation of the target company.
• The cash flow that is most appropriate is the free cash flow
(FCF), which is the cash flow after capital expenditures
necessary to maintain the company as an ongoing concern.
• The goal is to estimate future FCF.
– We can use pro forma financial statements to estimate FCF
– We use a two-stage model when we can more accurately
estimate growth in the near future and then assume a
somewhat slower growth out into the future.

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Calculate Net Interest after Tax
Estimating Free Cash Flow (FCF)
(Interest expense – Interest income) × (1 – Tax rate)

Calculate Unlevered Net Income

Net income + Net interest after tax

Calculate NOPLAT

Unlevered net income + Change in deferred taxes

Calculate FCF

NOPLAT + Noncash charges – Change in working capital – Capital expenditures

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8. Who benefits from Mergers?
• Mergers create value for the target company shareholders
in the short run.
• Acquirers tend to overpay in merger bids.
– The transfer of wealth is from acquirer to target
company shareholders.
– Roll: Overpayment results from “hubris.”
• Acquirers tend to underperform in the long run.
– They are unable to fully capture any synergies or other
benefit from the merger.

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Mergers that create value
• Buyer is strong.
• Transaction premiums are relatively low.
• Number of bidders are low.
• Initial market reaction to the news is favorable.

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10. Summary
• An acquisition is the purchase of some portion of one company by another,
whereas a merger represents the absorption of one company by another.
• Mergers may be a statutory merger, a subsidiary merger, or a consolidation.
• Horizontal mergers occur among peer companies engaged in the same kind of
business, vertical mergers occur among companies along a given value chain, and
conglomerates are formed by companies in unrelated businesses.
• Merger activity has historically occurred in waves.
– Waves have typically coincided with a strong economy and buoyant stock
market activity.
– Merger activity tends to be concentrated in a few industries, usually those
undergoing changes.
• There are number of motives for a merger or acquisition; some are justified, some
are dubious.

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Summary (continued)
• A merger transaction may take the form of a stock
purchase or an asset purchase.
– The decision of which approach to take will affect
other aspects of the transaction.
• The method of payment for a merger may be cash,
securities, or a mixed offering with some of both.
• Hostile transactions are those opposed by target
managers, whereas friendly transactions are endorsed by
the target company’s managers.
• There are a variety of both pre- and post-offer defenses a
target can use to ward off an unwanted takeover bid.
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Summary (continued)
• Pre-offer defense mechanisms include poison pills and puts, incorporation in a
jurisdiction with restrictive takeover laws, staggered boards of directors, restricted
voting rights, supermajority voting provisions, fair price amendments, and golden
parachutes.
• Post-offer defenses include “just say no” defense, litigation, greenmail, share
repurchases, leveraged recapitalization, “crown jewel” defense, “Pac-Man”
defense, or finding a white knight or a white squire.
• Antitrust legislation prohibits mergers and acquisitions that impede competition.
• The Federal Trade Commission and Department of Justice review mergers for
antitrust concerns in the United States. The European Commission reviews
transactions in the European Union.
• The Herfindahl–Hirschman Index (HHI) is a measure of market power based on the
sum of the squared market shares for each company in an industry.
• The Williams Act is the cornerstone of securities legislation for M&A activities in
the United States.

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Summary (continued)
• Three major tools for valuing a target company are discounted cash
flow analysis, comparable company analysis, and comparable
transaction analysis.
• In a merger bid, the gain to target shareholders is the takeover
premium. The acquirer gain is the value of any synergies created by
the merger, minus the premium paid to target shareholders.
• The empirical evidence suggests that merger transactions create
value for target company shareholders, yet acquirers tend to accrue
value in the years following a merger.
• A divestiture is a transaction in which a company sells, liquidates, or
spins off a division or a subsidiary.
• A company may divest assets using a sale to another company, a
spin-off to shareholders, or a liquidation.

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