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Transcript of 86778301 Ajay Verma Research Report
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G.L.A INSTITUTE OF TECHNOLOGY & MANAGEMENT,
MATHURA
MANAGEMENT RESEARCH PROJECT
2011
A REPORT ON
DIFFERENT FINANCING APPROACHES IN MERGER &
ACQUISITION
Under the guidance of Submitted by
Mr. Satyendra Yadav Ajay Kumar Verma
Roll no.-0906370006
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ACKNOWLEDGEMENT
I hereby like to express my thanks from the deepest portion of our heart to our
Director Mrs. REKHA SINGHAL, for forecasting the excellent academic
environment in the institute, which made this effort fruitful.
I express my deep sense of gratitude to Mr. Satyendra Yadav, Faculty of institute,
for his constant guidance and encouragement throughout the period of the projectstudy. I am indebted to his guidance, spirit and valuable suggestions.
In the last I would like to thank all staff members in the computer laboratory for
their troubleshooting expertise, directly or indirectly in various ways leading to
the successful completion of the study report, which helps me in report formation.
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Contents
Abstract
Objective
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Abstract
The project is basically to understand the various approaches of funding and
valuation in Merger &Acquisition. Study involves their deep knowledge and how
the companies are financing their acquisitions. In which all kinds a company can
raise the funds during mergers and acquisitions, which valuation approach is
efficient for the company to get valued?
Analyzing the recent mergers happened in Indian market. Understanding
what can be the various reasons which make companies to go for mergers and
acquisitions. What can be the right mix of debt, equity, cash and other loans and
advances in order to finance the acquisitions? Asses the overall impact of a
merger on company performance, Impact on financials of a company after the
merger and acquisition.
In India, the process of liberalization and globalization has influenced the
functioning and governance of Indian companies, forcing them to refocus their
strategies. In the process of refocusing, acquisitions have been a normal
phenomenon; they represent one of the most effective methods of corporate
restructuring and have become an integral part of the long-term business strategy
of corporate enterprises. A wide range of Indian companies have been active in
the Merger & Acquisition area. In the presently competitive environment, the
concept has been gaining increasing importance as a way of improving
competitiveness and efficiency. In the changing economic scenario, these have
emerged as a vital growth strategy among the corporate s and increasingly getting
accepted. In recent years, Indian companies have undertaken acquisitions in
international markets in order to globalize their operations and improve their
efficiency and international competitiveness.
Acquisitions have gained importance in recent times. Business
consolidation by large industrial houses, consolidation of business by
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multinationals operating in India, increasing competition amongst domestic
companies and competition against imports have all combined to drive
acquisitions activities in India. The role of mergers and acquisitions has evolved
as a strategy tool for fast-track technology-led companies. In the current rapidly
changing environment and in the era of systemic innovation, where technology is
embedded in people and processes, well-planned M&A are recognized as critical
to fast-track technology company success - and even survival.
The four main reasons for making an acquisition include:
1. To acquire complementary products, in order to broaden the line2. To acquire new markets or distribution channels3. To acquire additional mass, and benefit from economies of scale4. To acquire technology, to complement or replace the currently used
one.
Acquisition synergies are great as they may give companies the needed
technology, people, infrastructure, global sales, marketing and distribution
opportunities. This is the reason why the majority of technology companies that
go public tend to be acquired within two years after the flotation.
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Objective:
The objectives of this project are:
1. To study the various financing approaches through which a company canfinance its acquisitions
2. To study the various valuation approaches use for acquiring a company
3. To study the impact on acquired and acquirer company
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Main Idea
One plus one makes three: this equation is the special alchemy of a merger or anacquisition. The key principle behind buying a company is to create shareholder
value over and above that of the sum of the two companies. Two companies
together are more valuable than two separate companies - at least, that's the
reasoning behind Merger &Acquisition.
This rationale is particularly charming to companies when times are tough.
Strong companies will act to buy other companies to create a more competitive,
cost-efficient company. The companies will come together hoping to gain a
greater market share or to achieve greater efficiency. Because of these potential
benefits, target companies will often agree to be purchased when they know they
cannot survive alone.
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Distinction between Mergers and Acquisitions-
Although they are often spoken in the same breath and used as though they were
synonymous, the terms merger and acquisition mean slightly different things.
When one company takes over another and clearly established itself as the new
owner, the purchase is called an acquisition. From a legal point of view, the target
company ceases to exist, the buyer "swallows" the business and the buyer's stock
continues to be traded.
In the pure sense of the term, a merger happens when two firms, often of
about the same size, agree to go forward as a single new company rather than
remain separately owned and operated. This kind of action is more precisely
referred to as a "merger of equals." Both companies' stocks are surrendered and
new company stock is issued in its place. For example, both Daimler-Benz and
Chrysler ceased to exist when the two firms merged, and a new company,
DaimlerChrysler, was created.
In practice, however, actual mergers of equals don't happen very often.
Usually, one company will buy another and, as part of the deal's terms, simply
allow the acquired firm to proclaim that the action is a merger of equals, even if
it's technically an acquisition. Being bought out often carries negative
connotations, therefore, by describing the deal as a merger, deal makers and top
managers try to make the takeover more palatable.
A purchase deal will also be called a merger when both CEOs agree that
joining together is in the best interest of both of their companies. But when the
deal is unfriendly - that is, when the target company does not want to be
purchased - it is always regarded as an acquisition. Whether a purchase is
considered a merger or an acquisition really depends on whether the purchase is
friendly or hostile and how it is announced. In other words, the real difference
lies in how the purchase is communicated to and received by the target company's
board of directors, employees and shareholders
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Synergy-
Synergy is the magic force that allows for enhanced cost efficiencies of the new
business. Synergy takes the form of revenue enhancement and cost savings. By
merging, the companies hope to benefit from the following:
1. Staff reductions - As every employee knows, mergers tend to mean joblosses. Consider all the money saved from reducing the number of staff
members from accounting, marketing and other departments. Job cuts will
also include the former CEO, who typically leaves with a compensation
package.
2. Economies of scale - Yes, size matters. Whether it's purchasing stationeryor a new corporate IT system, a bigger company placing the orders can
save more on costs. Mergers also translate into improved purchasing power
to buy equipment or office supplies - when placing larger orders,
companies have a greater ability to negotiate prices with their suppliers.
3. Acquiring new technology - To stay competitive, companies need to stayon top of technological developments and their business applications. By
buying a smaller company with unique technologies, a large company can
maintain or develop a competitive edge.
4. Improved market reach and industry visibility - Companies buycompanies to reach new markets and grow revenues and earnings. A merge
may expand two companies' marketing and distribution, giving them new
sales opportunities. A merger can also improve a company's standing in the
investment community: bigger firms often have an easier time raising
capital than smaller ones.
That said, achieving synergy is easier said than done - it is not automatically
realized once two companies merge. Sure, there ought to be economies of scale,
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when two businesses are combined, but sometimes a merger does just the
opposite. In many cases, one and one add up to less than two.
Sadly, synergy opportunities may exist only I n the minds of the corporate
leaders and the deal makers. Where there is no value to be created, the CEO and
investment bankers - who have much to gain from a successful M&A deal - will
try to create an image of enhanced value. The market, however, eventually sees
through this and penalizes the company by assigning it a discounted share price.
We'll talk more about why M&A may fail in a later section of this tutorial.
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Acquisitions:
As you can see, an acquisition may be only slightly different from a merger. In
fact, it may be different in name only. Like mergers, acquisitions are actions
through which companies seek economies of scale, efficiencies and enhanced
market visibility. Unlike all mergers, all acquisitions involve one firm purchasing
another - there is no exchange of stock or consolidation as a new company.
Acquisitions are often congenial, and all parties feel satisfied with the deal. Other
times, acquisitions are more hostile.
In an acquisition, as in some of the merger deals we discuss above, a
company can buy another company with cash, stock or a combination of the two.
Another possibility, which is common in smaller deals, is for one company to
acquire all the assets of another company. Company X buys all of Company Y's
assets for cash, which means that Company Y will have only cash (and debt, if
they had debt before). Of course, Company Y becomes merely a shell and will
eventually liquidate or enter another area of business.
Another type of acquisition is a reverse merger, a deal that enables a
private company to get publicly-listed in a relatively short time period. A reverse
merger occurs when a private company that has strong prospects and is eager to
raise financing buys a publicly-listed shell company, usually one with no business
and limited assets. The private company reverse merges into the public company,
and together they become an entirely new public corporation with tradable shares.
Regardless of their category or structure, all mergers and acquisitions have
one common goal: they are all meant to create synergy that makes the value of
the combined companies greater than the sum of the two parts. The success of a
merger or acquisition depends on whether this synergy is achieved.
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Synergy: The Premium for Potential Success-
For the most part, acquiring companies nearly always pay a substantial premium
on the stock market value of the companies they buy. The justification for doing
so nearly always boils down to the notion of synergy; a merger benefits
shareholders when a company's post-merger share price increases by the value of
potential synergy.
Let's face it, it would be highly unlikely for rational owners to sell if they
would benefit more by not selling. That means buyers will need to pay a premium
if they hope to acquire the company, regardless of what pre-merger valuation tells
them. For sellers, that premium represents their company's future prospects. For
buyers, the premium represents part of the post-merger synergy they expect can
be achieved. The following equation offers a good way to think about synergy
and how to determine whether a deal makes sense. The equation solves for the
minimum required synergy.
In other words, the success of a merger is measured by whether the value of the
buyer is enhanced by the action. However, the practical constraints of mergers,
which we discuss in part five, often prevent the expected benefits from being
fully achieved. Alas, the synergy promised by deal makers might just fall short.
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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:
A reasonable purchase price - A premium of, say, 10% above the market price
seems within the bounds of level-headedness. A premium of 50%, on the other
hand, requires synergy of stellar proportions for the deal to make sense. Stay
away from companies that participate in such contests.
1. Cash transactions - Companies that pay in cash tend to be more carefulwhen calculating bids and valuations come closer to target. When stock is
used as the currency for acquisition, discipline can go by the wayside.
2. Sensible appetite An acquiring company should be targeting acompany that is smaller and in businesses that the acquiring company
knows intimately. Synergy is hard to create from companies in disparate
business areas. Sadly, companies have a bad habit of biting off more than
they can chew in mergers.
Mergers are awfully hard to get right, so investors should look for acquiring
companies with a healthy grasp of reality.
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Financing Of Acquisition:
Determine the Best Structure for the Acquisition-
The determination of whether to structure the purchase as an asset deal, a stock
deal or a merger of two companies with one as the surviving corporation will
have a significant impact not only on the net proceeds available to the seller from
the transaction but also the cost accounting for the transaction and the impact on
the business going forward. For example, making a Section 338 Election under
the Internal Revenue Code will enable a stock sale to be treated as an asset sale
for accounting purposes, a favorable result for the buyer if they can negotiate it as
a condition to closing.
On the other hand, structuring the transaction as an asset sale rather than a
stock sale will substantially reduce their potential exposure for successor liability
relating to the operation of the target business prior to closing. Think about the
seller/management as well. Does it make sense to persuade the seller to stay on
with the target business after the closing to help smooth the transition and
integrate the business and customer base or do you not want the seller involved
post-closing at all? Likewise, are the parties in agreement on price or not? If it
continues to be a hotly contested issue, an appropriate earn-out based on future
revenues over a fixed period of time may be what they need to offer to incentives
the seller and management post-closing. Theyll need to think about holdbacks as
well. If they have a reserve pool of funds in escrow or are paying part of the
purchase price by promissory note, they have an additional layer of protection
from future liabilities of the business pre-closing, provided the documents are
appropriately drafted. Accordingly, tax and legal advice from acquisition experts
can make a big difference in the price they may pay for this acquisition.
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What Sources of Financing Are Available?
After establishing the structure of the acquisition, they can focus on identifying
the most appropriate and efficient sources of financing. First determine if the
seller wants to cash out immediately or if they would be willing to support the
acquisition in the form of seller financing or other mechanisms such as
employment agreements, earn-out arrangements based on future earnings, and
consulting contracts. Although this source of financing can be used effectively to
finance all or part of an acquisition, it can result in a higher price tag or in
keeping the seller around after the transaction longer than they would prefer.
Consider using this source of financing as a component to bridge any gap
between sellers and their price expectations.
Next look to their business to see if they can leveraged their companys existing
assets and cash flow in the form of traditional bank financing to fund the
acquisition. Other sources of external financing can include acquisition loans
from commercial banks, subordinated debt/mezzanine financing from various
entities and equity financing from private firms or individuals. Commercial banks
provide senior debt at a low cost based upon tangible asset coverage and the
reliability of the historical cash flow generated by both company and the
acquisition target. Subordinated debt or mezzanine financing is a higher risk,
higher cost debt which is generally not covered by existing assets or cash flow
but is based on expectations for future cash flow generation and growth in the
companys value. Borrowing costs can include interest rates that are much higher
than bank debt and an equity component.
Both commercial banks and subordinated debt/mezzanine financing
providers will set specific financial targets for their company that measure,
among other things, ongoing cash flow generation, their liquidity and debt
burden. Make sure that these do not conflict with each other and that they have a
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comfortable cushion for any negative variance to their financial plan. Not being
able to adhere to these targets can be very expensive and cause their debt
providers to impose additional restrictions on company. Equity financing is
available from venture firms and private equity sources that expect the companies
they invest in to have strong performance that will yield significant returns within
a certain period of time. Equity providers, and to a lesser extent, subordinated
debt holders, expect to be directly involved with the management of their
company, and they will have to dilute their ownership position in exchange for
their investments. As a result, make sure these providers will be compatible
partners and that they share their vision for the future and that they provide some
added value in addition to their money.
The epidemic of corporate downsizing in the India has made owning a
business a more attractive proposition than ever before. As increasing numbers of
prospective buyers go aboard on the process of becoming independent business
owners, many of them voice a common concern: how do I finance the
acquisition?
Prospective buyers are aware that any credit crunch prevents the traditional
lending institution from being the likely solution to their needs. Where then, canbuyers turn for help with what is likely to be the largest single investment of their
lives? There are a variety of financing sources, and buyers can find one that fills
their particular requirements. For many businesses, the following are the best
routes to follow:
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Best Routes:
Buyer's Personal Equity-
In most business acquisition situations, this is the place to begin. Typically,
anywhere from 20 to 50 percent of cash needed to purchase a business comes
from the buyer and his or her family. Buyers should decide how much capital
they are able to risk, and the actual amount will vary, of course, depending on the
specific business and the terms of the sale. But, on average, a buyer should be
prepared to come up with something between $25,000 and $150,000.
The dream of buying a business by means of a highly-leveraged transaction
( one requiring minimum cash ) must remain a dream and not a reality for most
buyers. The exceptions are those buyers who have special talents or skills sought
after by investors, those whose business will directly benefit jobs that are of local
public interest, or those whose businesses are expected to make unusually large
profits.
One of the major reasons personal equity financing is a good starting point
is that buyers who invest their own capital start the ball rolling--they are
positively influencing other possible investors or lenders to participate.
Seller Financing-
One of the simplest--and best--ways to finance the acquisition of a business is to
work hand-in-hand with the seller. The seller's willingness to participate will be
influenced by his or her own requirements: tax considerations as well as cash
needs.
In some instances, sellers are virtually forced to finance the sale of their
own business in order to keep the deal from falling through. Many sellers,
however, actively prefer to do the financing themselves. Doing so not only can
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increase the chances for a successful sale, but can also be helpful in obtaining the
best possible price.
The terms offered by sellers are usually more flexible and more agreeable
to the buyer than those from a third-party lender. Sellers will typically finance 30
to 50 percent--or more--of the selling price, with an interest rate below current
bank rates and with a far longer amortization. The terms will usually have
scheduled payments similar to conventional loans; the tax picture, however, can
be better than with straight debt.
As with buyer-equity financing, seller financing can make the business
more attractive and viable to other lenders. In fact, sometimes outside lenders will
refuse to participate unless a large chunk of seller financing is already in place.
Venture Capital-
Venture capitalists have become more eager players in the financing ofindependent businesses. Previously known for going after the high-risk, high-
profile brand-new business, they are becoming increasingly interested in
established, existing entities.
This is not to say that outside equity investors are lining up outside the buyer's
door, especially if the buyer is counting on a single investor to take on this kind
of risk. Professional venture capitalists will be less daunted by risk; however,
they will likely want majority control and will expect to make at least 30 percent
annual rate of return on their investment.
Small Business Administration-
Thanks to the Indian Small Business Administration Loan Guarantee Program,
favorable financing terms are available to business buyers. Similar to the terms of
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typical seller financing, SBA loans have long amortization periods (ten years),
and up to 70 percent financing (more than usually available with the seller-
financed sale).
SBA loans are not, however, a given. The buyer seeking the loan must
prove stability of the business and must also be prepared to offer collateral--
machinery, equipment, or real estate. In addition, there must be evidence of a
healthy cash flow in order to insure that loan payments can be made. In cases
where there is adequate cash flow but insufficient collateral, the buyer may have
to offer personal collateral, such as his or her house or other property.
Over the years, the SBA has become more in tune with small business
financing. It now has a Lo-Doc program for loans under $100,000 that requires
only a minimum of paperwork. Another optimistic financing sign: more banks are
now being approved as SBA lenders.
Lending Institutions-
Banks and other lending agencies provide unsecured loans commensurate with
the cash available for servicing the debt. ("Unsecured" is a misleading term,
because banks and other lenders of this type will aim to secure their loans if the
collateral exists.) Those seeking bank loans will have more success if they have a
large net worth, liquid assets, or a reliable source of income. Unsecured loans are
also easier to come by if the buyer is already a favored customer or one
qualifying for the SBA loan program.
When a bank participates in financing a business sale, it will typically
finance 50 to 75 percent of the real estate value, 75 to 90 percent of new
equipment value, or 50 percent of inventory. The only intangible assets attractive
to banks are accounts receivable, which they will finance from 80 to 90 percent.
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Although the terms may sound attractive, most business buyers are unwise to
look toward conventional lending institutions to finance their acquisition. By
some estimates, the rate of rejection by banks for business acquisition loans can
go higher than 80 percent.
With any of the acquisition financing options, buyers must be open to
creative solutions, and they must be willing to take some risks. Whether the route
finally chosen is personal, seller, or third-party financing, the well-informed
buyer can feel confident that there is a solution to that big acquisition question.
Financing, in some form, does exist out there.
Leveraged Finance
Leveraged finance is funding a company or business unit with more debt than
would be considered normal for that company or industry. More-than-normal
debt implies that the funding is riskier, and therefore more costly, than normal
borrowing. As a result, levered finance is commonly employed to achieve a
specific, often temporary, objective: to make an acquisition, to effect a buy-out,
to repurchase shares or fund a one-time dividend, or to invest in a self-sustaining
cash-generating asset.
Although different banks mean different things when they talk leveraged finance,
it generally includes two main products - leveraged loans and high-yield bonds.
Leveraged loans, which are often defined as credits priced 125 basis points or
more over the London inter bank offered rate, are essentially loans with a high
rate of interest to reflect a higher risk posed by the borrower. High-yield or junk
bonds are those that are rated below "investment grade," i.e. less than triple-B.
A key instrument is much leveraged finance, particularly in leveraged buy-
outs, is mezzanine or "in between" debt. Mezzanine debt has long been used by
mid-cap companies in Europe and the US as a funding alternative to high yield
bonds or bank debt. The product ranks between senior bank debt and equity in a
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company's capital structure, and mezzanine investors take higher risks than bond
buyers but are rewarded with equity-like returns averaging between 15 and 20 per
cent.
Companies that are too small to tap the bond market have been the
traditional users of mezzanine debt, but it is increasingly being used as part of the
financing package for larger leveraged acquisition deals. Although mezzanine has
been more expensive for companies to use than junk bonds, the low coupons
coupled with high returns often makes some sort of mezzanine or hybrid debt an
essential buffer between senior lenders and the equity investors.
Leveraged Acquisition Finance
Leveraged Acquisition Finance is the provision of bank loans and the issue of
high yield bonds to fund acquisitions of companies or parts of companies by an
existing internal management team (a management buy-out), an external
management team (a management buy-in) or a third party (an acquisition).
The leverage of a transaction refers to the ratio of debt capital (bank loans and
bonds) to equity capital (money invested in the shares of the target company). In
a leveraged financing, this ratio is unusually high. As a result, the level of debt
service (payment of interest and repayment of principal) absorbs a very large part
of the cash flow produced by the business. Consequently, the risk of the company
not being able to service the debt is higher and thus the position of the lenders is
riskier than in a conventional acquisition. The interest rate on the debt will be
high.
Leveraged Recapitalizations-
A technique where by a public company takes on significant additional debt with
the purpose of either paying an extraordinary dividend or repurchasing shares,
leaving the public shareholders with a continuing interest in a more financially-
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leveraged company. This is often used as a "shark repellant" to ward off a hostile
takeover.
Leveraged Corporate Credit-
Leveraged corporate credit involves the provision and management of credit
products, including bank loans, bridge loans and high-yield debt, for below
investment grade companies that rely heavily on debt financing.
Leveraged Asset-Based Finance-
Leveraged asset-based finance entails raising debt capital for companies where
the physical assets or a defined, contractual cash flow form the basis for highly
levered non- or limited-recourse funding of assets or projects. Leasing, project
financing and whole business securitization are examples of these techniques.
Leveraged finance, like other parts of structured finance, primarily
involves identifying, analyzing and solving risks. These risks can be arranged
into the following groups:
Credit risks and financial risks-
Credit risks are concerned with the business and its market. Financial risks which
lie within the economy as a whole, for instance, interest rates, foreign exchangerates and tax rates.
Structural risks-
These are risks created by the actual provision of finance including legal,
documentation and settlement risks.
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There are often different layers of finance involved in leveraged financing. These
range from a senior secured bank loan or bond to a subordinated loan or bond. A
large part of the role of leveraged financiers is to calculate how each type of
finance should be raised. If they overestimate the ability of the company to
service its debt, they may lend too much at a low margin and be left holding loans
or bonds they cannot sell to the market. If the value of the company is
underestimated, the deal may be lost.
Management buyout-
A management buyout (MBO) is a form of acquisition where a company's
existing managers acquire a large part or all of the company.
Management buyouts are similar in all major legal aspects to any other
acquisition of a company. The particular nature of the MBO lies in the position of
the buyers as managers of the company and the practical consequences that
follow from that. In particular, the due diligence process is likely to be limited as
the buyers already have full knowledge of the company available to them. The
seller is also unlikely to give any but the most basic warranties to the
management, on the basis that the management know more about the company
than the sellers do and therefore the sellers should not have to warrant the state of
the company.
In many cases the company will already be a private company, but if it is
public then the management will take it private
The Purpose of an MBO-
The purpose of such a buyout from the managers' point of view may be to save
their jobs, either if the business has been scheduled for closure or if an outsidepurchaser would bring in its own management team. They may also want to
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maximize the financial benefits they receive from the success they bring to the
company by taking the profits for themselves. This is often a way to ward off
aggressive buyers.
Financing a Management Buyout
Debt Financing-
The management of a company will not usually have the money available to buy
the company outright themselves. They would first seek to borrow from a bank,
provided the bank was willing to accept the risk. Management buyouts arefrequently seen as too risky for a bank to finance the purchase through a loan.
Private Equity Financing-
If a bank is unwilling to lend, the management will commonly look to private
equity investors to fund the majority of buyout. A high proportion of
management buyouts are financed in this way. The private equity investors willinvest money in return for a proportion of the shares in the company, though they
may also grant a loan to the management. The exact financial structuring will
depend on the backer's desire to balance the risk with its return, with debt being
less risky but less profitable than capital investment.
Although the management may not have resources to buy the company,
private equity houses will require that the managers each make as large aninvestment as they can afford in order to ensure that the management are locked
in by an overwhelming vested interest in the success of the company. It is
common for the management re-mortgage their houses in order to acquire a small
percentage of the company.
Private equity backers are likely to have somewhat different goals to the
management. They generally aim to maximize their return and make an exit after
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3-5 years while minimizing risk to themselves, whereas the management rarely
look beyond their careers at the company and will take a long-term view.
While certain aims do coincide - in particular the primary aim of profitability -
certain tensions can arise. The backers will invariably impose the same warranties
on the management in relation to the company that the sellers will have refused to
give the management. This "warranty gap" means that the management will bear
all the risk of any defects in the company that affects its value.
As a condition of their investment, the backers will also impose numerous
terms on the management concerning the way that the company is run. The
purpose is to ensure that the management run the company in a way that will
maximize the returns during the term of the backers' investment, whereas the
management might have hoped to build the company for long-term gains. Though
the two aims are not always incompatible, the management may feel restricted.
Vendor Financing-
In certain circumstances it may be possible for the management and the original
owner of the company to agree a deal whereby the seller finances the buyout. The
price paid at the time of sale will be nominal, with the real price being paid over
the following years out of the profits of the company. The timescale for the
payment is typically 3-7 years.
This represents a disadvantage for the vendor, which must wait to receive
its money after it has lost control of the company. It is also dependent on the
returned profits being increased significantly following the acquisition, in order
for the deal to represent a gain to the seller in comparison to the situation pre-
sale. This will usually only happen in very particulate circumstances.
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The vendor may nevertheless agree to vendor financing for tax reasons, as the
consideration will be classified as income rather than a capital gain. It may also
receive some other benefit such as a higher overall purchase price than would be
obtained by a normal purchase.
The advantage for the management is that they do not need to become involved
with private equity or a bank and will be left in control of the company once the
consideration has been paid.
Management buy-in-
A management buy in (MBI) occurs when a manager or a management team
from outside the company raises the necessary finance, buys it and becomes the
company's new management. A management buy-in team often competes with
other purchasers in the search for a suitable business. Usually, the team will be
led by a manager with significant experience at managing director level. The
difference to a management buy-out is in the position of the purchaser: in the case
of a buy-out, they are already working for the company. In the case of a buy-in,
however, the manager or management team is from another source
Initial public offering-
An initial public offering (IPO) is the first sale of a corporation's common shares
to public investors. The main purpose of an IPO is to raise capital for the
corporation. While IPOs are effective at raising capital, they also impose heavy
regulatory compliance and reporting requirements. The term only refers to the
first public issuance of a company's shares; any later public issuance of shares is
referred to as a Secondary Market Offering. A shareholder selling its existing
(rather than shares newly issued to raise capital) shares to public on the Primary
Market is an Offer for Sale
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Procedure-
IPOs generally involve one or more investment banks as "underwriters." The
company offering its shares, called the "issuer," enters a contract with a leadunderwriter to sell its shares to the public. The underwriter then approaches
investors with offers to sell these shares.
The sale (that is, the allocation and pricing) of shares in an IPO may take several
forms. Common methods include:
Dutch auctionFirm commitmentBest effortsBought dealSelf Distribution of Stock
A large IPO is usually underwritten by a "syndicate" of investment banks led by
one or more major investment banks (lead underwriter). Upon selling the shares,
the underwriters keep a commission based on a percentage of the value of the
shares sold. Usually, the lead underwriters, i.e. the underwriters selling the largest
proportions of the IPO, take the highest commissionsup to 8% in some cases.
Multinational IPOs may have as many as three syndicates to deal with differing
legal requirements in both the issuer's domestic market and other regions. (e.g.,
an issuer based in the E.U. may be represented by the main selling syndicate in its
domestic market, Europe, in addition to separate syndicates or selling groups for
US/Canada and for Asia. Usually the lead underwriter in the main selling group is
also the lead bank in the other selling groups.)Because of the wide array of legal
requirements, IPOs typically involve one or more law firms with major practices
in securities law, such as the Magic Circle firms of London and the white shoe
firms of New York City.
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Usually the offering will include the issuance of new shares, intended to raise
new capital, as well the secondary sale of existing shares. However, certain
regulatory restrictions and restrictions imposed by the lead underwriter are often
placed on the sale of existing shares.
Public offerings are primarily sold to institutional investors, but some
shares are also allocated to the underwriters' retail investors. A broker selling
shares of a public offering to his clients is paid through a sales credit instead of a
commission. The client pays no commission to purchase the shares of a public
offering, the purchase price simply includes the built in sales credit.
The issuer usually allows the underwriters an option to increase the size of the
offering by up to 15% under certain circumstance known as over-allotment
option.
Leveraged buyout-
A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or
"bootstrap" transaction) occurs when a financial sponsor gains control of a
majority of a target company's equity through the use of borrowed money or debt.
A leveraged buyout is a strategy involving the acquisition of another company
using a significant amount of borrowed money (bonds or loans) to meet the cost
of acquisition. Often, the assets of the company being acquired are used as
collateral for the loans, in addition to the assets of the acquiring company. Thepurpose of leveraged buyouts is to allow companies to make large acquisitions
without having to commit a lot of capital. In an LBO, there is usually a ratio of
70% debt to 30% equity.
In the industry's infancy in the late 1960s the acquisitions were called
"bootstrap" transactions, and were characterized by Victor Posner's hostile
takeover of Sharon Steel Corp. in 1969. The industry was conceived by people
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like Jerome Kohlberg, Jr. while working on Wall Street in the 1960s and 1970s,
and pioneered by the firm he helped found with Henry Kravis, Kohlberg Kravis
Roberts & Co. (KKR).
KKR is credited by Harvard Business School as completing what is
believed to be the first leveraged buyout in business history, through the
acquisition of Orkin Exterminating Company in 1964. However, the first LBO
may have been the purchase by McLean Industries, Inc. of Waterman Steamship
Corporation in May 1955. Under the terms of that transaction, McLean borrowed
$42 million and raised an additional $7 million through issue of preferred stock.
When the deal closed, $20 million of Waterman cash and assets were used to
retire $20 million of the loan debt. The newly elected board of Waterman then
voted to pay an immediate dividend of $25 million to McLean Industries. [1]
A special case of such acquisition is a management buyout (MBO), which occurs
when a company's managers buy or acquire a large part of the company. The goal
of an MBO may be to strengthen the managers' interest in the success of the
company. In most cases, the management will then take the company private.
MBOs have assumed an important role in corporate restructurings beside mergers
and acquisitions. Key considerations in an MBO are fairness to shareholders,
price, the future business plan, and legal and tax issues.
A leveraged balance sheet has a small portion of equity capital and
therefore a large portion of loan capital. The return (profit) of the firm will be
"leveraged" to the equity capital and produce a large return on equity (ROE) for
the owners risking their money.
Typically, the loan capital is borrowed through a combination of
prepayable bank facilities and/or public or privately placed bonds, which may be
classified as high-yield debt, also called junk bonds. Often, the debt will appear
on the acquired company's balance sheet and the acquired company's free cash
flow will be used to repay the debt.
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The purposes of debt financing for leveraged buyouts are two-fold:
The use of debt increases (leverages) the financial return to the private equity
sponsor. Under the Modigliani-Miller theorem,[2] the total return of an asset toits owners, ceteris paribus and within strict restrictive assumptions, is unaffected
by the structure of its financing. As the debt in an LBO has a relatively fixed,
albeit high, cost of capital, any returns in excess of this cost of capital flow
through to the equity.
The tax shield of the acquisition debt, according to the Modigliani-Miller
theorem with taxes, increases the value of the firm. This enables the privateequity sponsor to pay a higher price than would otherwise be possible. Because
income flowing through to equity is taxed, while interest payments to debt are
not, the capitalized value of cash flowing to debt is greater than the same cash
stream flowing to equity.
Historically, many LBOs in the 1980s and 1990s focused on reducing
wasteful expenditures by corporate managers whose interests were not alignedwith shareholders. After a major corporate restructuring, which may involve
selling off portions of the company and severe staff reductions, the entity would
likely be producing a higher income stream. Because this type of management
arbitrage and easy restructuring has largely been accomplished, LBOs today
(2006) focus more on growth and complicated financial engineering to achieve
their returns. Most leveraged buyout firms look to achieve an internal rate ofreturn in excess of 20%.
Mergers and Acquisitions: Valuation Matters
Investors in a company that is aiming to take over another one must determine
whether the purchase will be beneficial to them. In order to do so, they must ask
themselves how much the company being acquired is really worth.
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Naturally, both sides of 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. Comparative Ratios - The following are two examples of the manycomparative metrics on which acquiring companies may base their offers:
Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, anacquiring 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.
2. Replacement Cost - In a few cases, acquisitions are based on the cost ofreplacing 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.
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3. Discounted Cash Flow (DCF)- A key valuation tool in M&A, discountedcash flow analysis determines a company's current value according to its
estimated future cash flows. Forecasted free cash flows (operating profit +
depreciation + amortization of goodwillcapital expenditurescash taxes
- 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.
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Original Cases Of mergers-
Now with the following three cases I will discuss the synergies for the mergers.
I.
Hindalco - Novelis acquisition
II. Reliance Industries Ltd. & Reliance Petroleum MergerIII. Arcelor - Mittal steel merger.IV. Tata-Corus steel merger.V. Hutch Vodafone Telecom merger.
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1.HINDALCO - NOVELIS ACQUISITIONAluminium and copper major Hindalco Industries, the Kumar Mangalam Birla-
led Aditya Birla Group flagship, acquired Canadian company Novelis Inc in a $6-
billion, all-cash deal in February 2007.
Till date, it is India's third-largest M&A deal.
The acquisition would make Hindalco the global leader in aluminium rolled
products and one of the largest aluminium producers in Asia. With post-
acquisition combined revenues in excess of $10 billion, Hindalco would enter the
Fortune-500 listing of world's largest companies by sales revenues.
Aditya Birla Group's Hindalco Industries Limited, India's largest non-
ferrous metals company, and Novelis Inc. (NYSE: NVL) (TSX: NVL), the
world's leading producer of aluminium rolled products, today announced that
they have entered into a definitive agreement for Hindalco to acquire Novelis in
an all-cash transaction which values Novelis at approximately US$6 billion,
including approximately US $2.40 billion of debt. Under the terms of the
agreement, Novelis shareholders will receive US $44.93 in cash for each
outstanding common share.
Based in Mumbai, India, Hindalco is a leader in Asia's aluminium and
copper industries, and is the flagship company of the Aditya Birla Group, a $12
billion multinational conglomerate, with a market capitalisation in excess of $20
billion. Following the transaction Hindalco, with Novelis, will be the world's
largest aluminium rolling company, one of the biggest producers of primary
aluminium in Asia, and India's leading copper producer.
Mr. Kumar Mangalam Birla, Chairman of the Aditya Birla Group, said,
"The acquisition of Novelis is a landmark transaction for Hindalco and our
Group. It is in line with our long-term strategies of expanding our global presence
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across our various businesses and is consistent with our vision of taking India to
the world. The combination of Hindalco and Novelis will establish a global
integrated aluminium producer with low-cost alumina and aluminium production
facilities combined with high-end aluminium rolled product capabilities. The
complementary expertise of both these companies will create and provide a
strong platform for sustainable growth and ongoing success."
Acting Chief Executive Officer of Novelis, Mr. Ed Blechschmidt, said,
"After careful consideration, the Board has unanimously agreed that this
transaction with Hindalco delivers outstanding value to Novelis shareholders.
Hindalco is a strong, dynamic company. The combination of Novelis' world-class
rolling assets with Hindalco's growing primary aluminium operations and its
downstream fabricating assets in the rapidly growing Asian market is an exciting
prospect. Hindalco's parent, the Aditya Birla Group, is one of the largest and
most respected business groups in India, with growing global activities and a
long-term business view."
Mr. Debu Bhattacharya, Managing Director of Hindalco and Director of
Aditya Birla Management Corporation Ltd., said, "There are significant
geographical market and product synergies. Novelis is the global leader in
aluminum rolled products and aluminum can recycling, with a global market
share of about 19 per cent. Hindalco has a 60 per cent share in the currently small
but potentially high-growth Indian market for rolled products. Hindalco's positionas one of the lowest cost producers of primary aluminium in the world is
leverageable into becoming a globally strong player. The Novelis acquisition will
give us immediate scale and a global footprint."
The transaction has been unanimously approved by the Boards of Directors
of both companies. The closing of the transaction is not conditional on Hindalco
obtaining financing.
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The transaction will be completed by way of a plan of arrangement under
applicable Canadian law. It will require the approval of 66.66 per cent of the
votes cast by shareholders of Novelis Inc. at a special meeting to be called to
consider the arrangement followed by court approval. The closing of the
transaction will also be subject to customary conditions including regulatory
approvals, and is expected to be completed during the second quarter of 2007
Mergers and Acquisitions have been the part of inorganic growth strategy of
corporate worldwide. Post 1991 era witnessed growing appetite for takeovers by
Indian corporate also across the globe as a part of their growth strategy. This
series of acquisitions in metal industry was initiated by acquisition of Arcelor by
Mittal followed by Corus by Tatas. Indian aluminium giant Hindalco extended
this process by acquiring Atlanta based company Novelis Inc, a world leader in
aluminium rolling and flat-rolled aluminium products. Hindalco Industries Ltd.,
acquired Novelis Inc. to gain sheet mills that supply can makers and car
companies. Strategically, the acquisition of Novelis takes Hindalco onto the
global stage as the leader in downstream aluminium rolled products. Theacquisition of Novelis by Hindalco bodes well for both the entities. Novelis,
processes primary aluminium to sell downstream high value added products. This
is exactly what Hindalco manufactures. This makes the marriage a perfect fit.
Currently Hindalco, an integrated player, focuses largely on manufacturing
alumina and primary aluminium. It has downstream rolling, extruding and foil
making capacities as well, but they are far from global scale. Novelis processes
around 3 million tonnes of aluminium a year and has sales centers all over the
world. In fact, it commands a 19% global market share in the flat rolled products
segment, making it a leader.
Hindalco has completed this acquisition through its wholly-owned
subsidiary AV Metals Inc and has acquired 75.415 common shares of Novelis,
representing 100 percent of the issued and outstanding common shares AV
Metals Inc transferred the common shares of Novelis to its wholly-owned
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subsidiary AV Aluminium Inc. The deal made Hindalco the world's largest
aluminium rolling company and one of the biggest producers of primary
aluminium in Asia, as well as being India's leading copper producer. Hindalco
Industries Ltd has completed its acquisition of Novelis Inc under an agreement in
which Novelis will operate as a subsidiary of Hindalco.
About Novelis-
Novelis is the global leader in aluminium rolled products and aluminium can
recycling. The company operates in 11 countries, has approximately 12,500
employees and reported $8.4 billion in 2005 revenue. Novelis has the unrivaled
capability to provide its customers with a regional supply of technologically
sophisticated rolled aluminium products throughout Asia, Europe, North America
and South America. Through its advanced production capabilities, the company
supplies aluminium sheet and foil to the automotive and transportation, beverage
and food packaging, construction and industrial, and printing markets.
Visit- www.novelis.com
About the Aditya Birla Group
The Aditya Birla Group is India's first truly multinational corporation, with aworkforce of 85,000 employees belonging to over 20 different nationalities. Its
74 state-of-the-art manufacturing units and service facilities span India, Thailand,
Laos, Indonesia, Philippines, Egypt, Canada, Australia, China, USA, UK,
Germany, Hungary and Portugal. A premium conglomerate, the Aditya Birla
Group participates in wide range of market sectors including viscose staple fiber,
non-ferrous metals, cement, viscose filament yarn, branded apparel, carbon black,
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chemicals, fertilizers, sponge iron, insulators, financial services, telecom, BPO
and IT services.
Visit-www.adityabirla.com
About Hindalco
Established in 1958, Hindalco is currently structured into two strategic
businesses, aluminium and copper, with 2006 revenues of approximately $2.6
billion. Hindalco's integrated operations and operating efficiency have positioned
the company as Asia's largest integrated primary producer of aluminium and
among the most cost-efficient producers globally. Its copper smelter is the
world's largest custom smelter at a single location. Hindalco stock is publicly
traded on the Bombay Stock Exchange (BSE) and the National Stock Exchange
of India Ltd (NSE). Its current market capitalisation is US$ 4.3 billion.
Visit-www.hindalco.com
IMPORTANT FACTS ABOUT DEAL-
Organic and inorganic both strategies have worked for companies worldwide. But
in the process of global expansions inorganic growth strategies has always been
the first preference for the companies globally. As a part of its inorganic growth
strategy of global expansion, the following points highlight the important points
about this acquisition of Hindalco for this acquisition:
The acquisition of Novelis by Hindalco was in an all-cash transaction,which values Novelis at enterprise value of approximately US $6.0 billion,
including approximately US $2.4 billion of debt.
http://www.adityabirla.com/http://www.adityabirla.com/http://www.adityabirla.com/http://www.hindalco.com/http://www.hindalco.com/http://www.hindalco.com/http://www.adityabirla.com/ -
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This merger of Novelis into Hindalco will establish a global integratedaluminium producer with low-cost alumina and aluminium production
facilities combined with high -end aluminium rolled product capabilities.
After merger Hindalco will emerge as the biggest rolled aluminiumproducts maker and fifth -largest integrated aluminium manufacturer in the
world.
As Novelis is the global leader in aluminium rolled products andaluminium can recycling, with a global market share of about 19%.
Hindalco has a 60% share in the currently small but potentially high-
growth Indian market for rolled products.
Hindalco's position as one of the lowest cost producers of primaryaluminium in the world is leverageable into becoming a globally strong
player. The Novelis acquisition will give the company immediate scale and
strong a global footprint.
Novelis is a globally positioned organization, operating in 11 countrieswith approximately 12,500 employees. In 2005, the company reported net
sales of US $8.4 billion and net profit of US $90 million.
The company reported net sales of US $7.4 billion and net loss of US $170million in nine months during 2006, on account of low contract prices.
Some of these contracts are expected to continue for next years also.
Novelis is expecting the full year loss to be US $263 million in 2006,however the company is expecting to be in black with US $68 million
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profit in 2007. The 7 total free cash flow is expected to be US $175 million
in 2006.
By January 1,2010, all the sales contracts will get expired and profitabilitywill increase substantially from then onwards.
Novelis will work as a forward integration for Hindalco as the company isexpected to ship primary aluminium to Novelis for downstream value
addition.
Novelis has a rolled product capacity of approximately 3 million tonnewhile Hindalco at the moment is not having any surplus capacity of
primary aluminium.
Hindalcos green field expansion will give it primary aluminium capacityof approximately 1 million tonne, but this will take a minimum 3-4 years to
all the capacities to come into operation. Novelis profitability is adversely
related to aluminium prices and higher aluminium prices on LME in near
future cant be ruled out. However, we expect the aluminium prices to be
softening in long term and this would be positive for Novelis.
Considering these factors, Hindalcos profitability is expected to remainunder pressure and this will bounce back in 2009-10. The profitability will
be accretive only in 2010-11.
The debt component of Novelis stood at US $2.4 billion and additional US$2.8 billion will be taken by Hindalco to finance the deal. This will put
tremendous pressure on profitability due to high interest burden.
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Hindalcos existing expansion will cost Rs. 25,000 crore and as a resultdebt and interest burden of the company will increase further.
CRISIL has placed its outstanding long-term rating of AAA/Stable onHindalco Industries Limited (Hindalco), on Rating Watch with Negative
Implications. The short term rating of P1+ has been reaffirmed. This
would lead to higher interest rate for the company.
FUNDING STRUCTURE FOR THE DEAL-
The funding structure of this deal is remarkably different from the
leveraged buyout model that Tata Steel used to fund the Corus buy.
The Tatas are to buy 100 per cent of Corus equity for $12.1 billion.
Only $4.1 billion of this is being raised by the Tatas. The remaining
$8 billion will be raised (as debt) and repaid on the strength of the
Corus balance sheet. Effectively, the Tatas are paying only a third
of the acquisition price. This was possible because Corus hadrelatively low debt on its balance sheet and was able to borrow
more. But that is not the case with Novelis. With a debt-equity ratio
of 7.23:1, it cant borrow any more. So, the Birlas were unable to do
a leverage buyout. To buy the $3.6 billion worth of Noveliss equity,
Hindalco is now borrowing almost $2.85 billion (of the balance,
$300 million is being raised as debt from group companies and $450
million is being mobilised from its cash reserves). That is almost athird of the Rs 2,500 crore net profit Hindalco may post in 2006-07.
(It has reported a net profit of Rs 1,843 crore for the first three
quarters of this year.) The second part of the deal is the $2.4-billion
debt on Noveliss balance sheet. Hindalco will have to refinance
these borrowings, though they will be repaid with Noveliss cash
flows.
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ISSUES AND DISCUSSION-
The case study attempts to analyze the financial and strategic implications of
this acquisition for the shareholders of hindalco. The case discusses the
acquisition of US-Canadian aluminium company Novelis by India-based
Hindalco Industries Limited (Hindalco), a part of Aditya 8 Vikram Birla
Group of Companies, in May 2007. The case explains the acquisition deal in
detail and highlights the benefits of the deal for both the companies.
Followings are the main issues to be discussed for critical review of this case:
what is strategic rationale for this acquisition?
Were the valuation for this Acquisition was correct?
what are financial Challenges for this Acquisition?
what is future outlook for this acquisition?
STRATEGIC RATIONALE FOR ACQUISITION-
This acquisition was a very good strategic move from Hindalco. Hindalco will be
able to ship primary aluminium from India and make value-added products.'' The
combination of Hindalco and Novelis establishes an integrated producer with
low-cost alumina and aluminium facilities combined with high-end rolling
capabilities and a global footprint. Hindalcos rationale for the acquisition is
increasing scale of operation, entry into highend downstream market and
enhancing global presence.
Novelis is the global leader (in terms of volume) in rolled products with annual
production capacity of 2.8 million tonnes and a market share of 19 per cent. It has
presence in 11 countries and provides sheets and foils to automotive and
transportation, beverage and food packaging, construction and industrial, and
printing markets. Hindalcos rationale for the acquisition is increasing scale of
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operation, entry into highend downstream market and enhancing global
presence.
Acquiring Novelis will provide Aditya Birla Group's Hindalco with access to
customers such as General Motors Corp. and Coca-Cola Co. Indian companies,
fueled by accelerating domestic growth, are seeking acquisitions overseas to add
production capacity and find markets for their products. Tata Steel Ltd. spent US
$12 billion last month to buy U.K. steelmaker Corus Group Plc. Novelis has
capacity to produce 3 million tonne of flat- rolled products, while Hindalco has
220,000 tonne. ``This acquisition gives Hindalco access to higher-end products
but also to superior technology,'' Hindalco plans to triple aluminium output to 1.5
million metric tonne by 2012 to become one of the world's five largest producers.
The company, which also has interests in telecommunications, cement, metals,
textiles and financial services, is the world's 13th-largest aluminium maker. After
the deal was signed for the acquisition of Novelis, Hindalco's management issued
press releases claiming that the acquisition would further internationalize its
operations and increase the company's global presence. By acquiring Novelis,
Hindalco aimed to achieve its long-held ambition of becoming the world's
leading producer of aluminium flat rolled products. Hindalco had developed
long-term strategies for expanding its operations globally and this acquisition was
a part of it. Novelis was the leader in producing rolled products in the Asia-
Pacific, Europe, and South America and was the second largest company in North
America in aluminium recycling, metal solidification and in rolling technologies
worldwide. The benefits from this acquisition can be discussed under the
following points:
Post acquisitions, the company will get a strong global footprint.After full integration, the joint entity will become insulated from the
fluctuation of LME Aluminium prices.
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The deal will give Hindalco a strong presence in recycling of aluminiumbusiness.As per aluminium characteristic, aluminium is infinitely
recyclable and recycling it requires only 5% of the energy needed to
produce primary aluminium.
Novelis has a very strong technology for value added products and itslatesttechnology Novelis Fusion is very unique one.
It would have taken a minimum 8-10 years to Hindalco for building thesefacilities, if Hindalco takes organically route.
As per company details, the replacement value of the Novelis is US $12billion, so considering the time required and replacement value; the deal is
worth for Hindalco.
Novelis being market leader in the rolling business, has invested heavily in
developing various production technology. One of such technology is a fusion
technology that increases the formability of aluminium. This means that it can be
better used formed into the design requirement by the car companies. All raw
aluminium is processed so that it can be used in products. Fourty percent of the
products are rolled products and Novelis is in leader in rolling business with a
market share of 20%. Any change in the raw material price is directly passed on
to the customers who range from coca cola to automobile companies like Aston
martin. The current revenue of hindalco is very much dependent on the
aluminium prices and when the prices are high they make a larger margin, this
not the case with rolling business which usually has a constant margin. For
Hindalco to develop such technology will take a lot of time. According to
Standard and Poors it would take 10 years and $ 12 billion to build the 29 plants
that Novelis has with capacity of close to 3 million tonnes. The takeover of
Novelis provides Hindalco with access to the leading downstream aluminium
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player in western markets. The purchase structurally shifts Hindalco from an
upstream aluminium producer to a downstream producer.
VALUATION FOR ACQUISITION-
The big concern is Noveliss valuation. Analysts believe the Birlas are paying too
high a price for a company that incurred a loss of US $170 million for the nine
months ended 30 September 2006. In its latest guidance, the Novelis management
has indicated a loss of US $240 million- 285 million for the whole of 2006. Even
in 2005, when Novelis had made a US $90-million net profit, its share prices
never crossed US $30. Financial numbers show that novelis is not a good choice
by Hindalco at least at the price that they paid for the company. The immediate
effect of the merger is that Hindalco would achieve its target of doubling its
turnover to $ 20 billion three years in advance. Novelis fits well in the long term
strategy of Hindalco. Novelis is not a dying company looking for a savior,
Hindalco approached Novelis because they believed that Novelis can give them
some business advantage. So, why is Hindalco paying US $44.93 a share for a
loss-making company? In its guidance, the Novelis management has indicated a
pre-tax profit of US $35 million-100 million for 2007. Going by the optimistic
end of the guidance, the price Hindalco paid translates to a market
capitalization/profit before tax (PBT) multiple of 36 on Noveliss 2007 forecast.
That appears to be high.
Hindalco has long held an ambition to become a leading (top 10) player across its
2 key business segments, aluminium and copper. The acquisition of Novelis
should achieve part of this goal by 10 propelling Hindalco to the worlds leading
producer of aluminium flat rolled products. With capacity of nearly 3.0 mt of flat
rolled aluminium products, Novelis takes Hindalco down the value chain to
become a downstream aluminium producer, versus its current upstream focus. At
a price of US $44.93/share and assuming US $2.4 bn of debt, Novelis is not
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coming cheaply. Based on Novelis guidance and consensus forecasts for 2007,
we estimate that Hindalco is paying 11.4x EBITDA, 20.7x EBIT or 53.4x PE. At
a total enterprise value of US $ 6 billion, Novelis is nearly 50% larger than
Hindalcos current market capitalization. The concern is the severity of the
earnings and value dilution that will result. Assuming synergies are minimal and
based on Novelis guidance for 2007; we calculate that Hindalcos EPS will be
diluted by 18%. At Novelis long term annual free cash flow target of US $400m
(using a real WACC of 9%), we estimate the acquisition will destroy value by
INR60/share. To put it another way, we estimate Hindalco will need to improve
annual free cash flow by 35% to US $540m for the acquisition to be value (NPV)
neutral. Perhaps the greatest issue with the Novelis acquisition is Hindalcos
balance sheet position post acquisition. Having already committed to significant
expansion projects, Novelis will push Hindalcos high gearing levels even
further. We calculate that Hindalcos gearing (ND/E) will reach 236%, with its
Net Debt / EBITDA ratio reaching over 5.0x. In our view, an equity raising is
highly possible in the short to medium term. For the nine-months to Sep06,Novelis reported a loss of US $170m. A key factor behind the losses suffered in
2006 was price ceilings contracted to Novelis long-term can-making customers,
which impacted revenues by US $350m. Novelis believes that their exposure to
these types of contracts will reduce to a maximum of 10% of sales in 2007. While
this is comforting, we believe Novelis remains a challenging turnaround prospect.
Based on Novelis guidance for 2007 and assuming this is relevant to Hindalcos
FY08 period, we calculate Hindalcos EPS will be diluted by 18%.
FINANCIAL CHALLENGES FOR THE ACQUISITION-
The acquisition will expose Hindalco to weaker balance sheet. Besides the
company will move from high margin metal business to lowmargin down
stream products business. The acquisition will more than triple Hindalcos
revenues, but will increase the debt and erode its profitability. The deal will
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create value only after the Hindalcos expansion completion, and due to its highly
leveraged position, expansion plans may get affected. Some of the customers of
Novelis are significant to the companys revenues, and that could be adversely
affected by changes in the business or financial condition of these significant
customers or by the loss of their business. (The companys ten largest customers
accounted for approximately 40% of total net sales in 2005, with Rexam Plc and
its affiliates representing approximately 12.5% of companys total net sales in
that year).
Novelis profitability could be adversely affected by the inability to pass through
metal price increases due to metal price ceilings in certain of the companys sales
contracts. Adverse changes in currency exchange rates could negatively affect the
financial results and the competitiveness of companys aluminium rol led products
relative to other materials. The Companys agreement not to compete with Alcan
in certain end-use markets may hinder Novelis ability to take advantage of new
business opportunities. The end-use markets for certain of Novelis products are
highly competitive and customers are willing to accept substitutes for the
company products.
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2.RELIANCE INDUSTRIES AND RELIANCE PETROLEUM-MERGER
Merger is Indias largest everRPL shareholders to receive 1 (one) share of RIL for every 16 (sixteen)
shares of RPL
RILs holding in RPL to be cancelled. No fresh treasury stock createdRIL to be a top 10 private sector refining company globallyRIL to become the worlds largest producer of Ultra Clean Fuels at single
location
Merger to unlock greater efficiency from scale and synergiesMerger to be EPS accretive RIL to have 3.7 million shareholders
The Boards of Directors of Reliance Industries Limited (RIL) and Reliance
Petroleum Limited (RPL) today unanimously approved RPLs merger with
RIL, subject to necessary approvals. The exchange ratio recommended by
both boards is 1 (one)share of RIL for every 16 (sixteen) shares of RPL. RIL
will issue 6.92 crores new shares, thereby increasing its equity capital to Rs
1,643 crore.
Reliance Industries Limited-
Reliance Industries Limited (RIL) is India's largest private sector company on all
major financial parameters with a turnover of Rs. 1,39,269 crore (US$ 34.7
billion), cash profit of Rs. 25,205 crore (US$ 6.3 billion), net profit (excluding
exceptional income) of Rs. 15,261 crore (US$ 3.8 billion) and net worth of Rs.
81,449 crore (US$ 20.3 billion) as of March 31, 2008.
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RIL is the first private sector company from India to feature in the Fortune
Global 500 list of 'World's Largest Corporations' and ranks 103rd amongst the
world's Top 200 companies in terms of profits. RIL is amongst the 30 fastest
climbers ranked by Fortune. RIL features in the Forbes Global list of the world's
400 best big companies and in the FT Global 500 list of the world's largest
companies. RIL ranks amongst the 'Worlds 25 Most Innovative Companies' as
per a list compiled by the US financial publication-Business Week in
collaboration with the Boston Consulting Group.
Reliance Petroleum Limited-
Reliance Petroleum Limited (RPL) is a subsidiary of Reliance Industries Limited.
RPL is setting up a green field petroleum refinery and polypropylene plant in a
Special Economic Zone at Jamnagar in Gujarat. With an annual crude processing
capacity of 580,000 barrels per stream day (BPSD), RPL will be the sixth largest
refinery in the world.
Reasons to buy-
Plan your business strategies by understanding your competitors' dealmaking approach, acquisition trends and market entry/expansion strategies;
Identify the latest consolidation trends in the market(s) you compete in;
Exploit Mergers and Acquisitions opportunities by understanding thestrategic rationale and success factors behind each deal; and
Design your inorganic strategies by screening potential acquisitionprospects in the markets
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Merger Benefits and Synergies:
The merger will unlock significant operational and financial synergies that
exist between RIL and RPL. It creates a platform for value-enhancing growth
and reinforces RILs position as an integrated global energy company.
The merger will enhance value for shareholders of both companies. The
merger is EPS accretive for RIL. Through this merger, RIL consolidates a world-
class, complex refinery with minimal residual project risk, while complementing
RILs product range. There will be further gains from reduced operating costs
arising from synergies of a combined operation.
The merger will result in RIL:
Operating two of the worlds largest, most complex refineries
Owning 1.24 million barrels per day (MBPD) of crude processing capacity,the largest refining capacity at any single location in the world
Emerging as the worlds 5th largest producer of Polypropylene
Merger Details:
Under the terms of the proposed merger, RPL shareholders will receive 1(one) share of RIL for every 16 (sixteen) RPL shares held by them.
The appointed date of merger of RPL with RIL is 1st April 2008.
RIL will cancel its holding in RPL.
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Based on the recommended merger ratio, RIL will issue 6.92 crore newequity shares to the existing shareholders of RPL. This will result in a 4.4%
increase in equity base from
Rs 1,574 crore to Rs 1,643 crore. Consequently, the promoter holding inRIL will reduce from 49.0% to 47.0%
Integrating businesses. The RIL-RPL merger had been widely expected for
some time. The Ambanis had quashed rumours about it in June 1998, but market
players always believed that a merger was only a matter of time. They were
proved right. With operations stabilising at RPL, the next logical step was to
merge it with the parent company, to realise the benefits of cost-efficiency and
cash in on productivity gains that come from integration.
By bringing RPL into its fold, the entire groups interests in the oil sector
have been consolidated under RIL. The company has made a successfulbeginning in exploration and production of crude oil. It currently has interests in
25 oil and gas blocks and is expected to spend $350 million (around Rs 1,700
crore) on oil exploration and production activities over the next three years. The
company expects to begin drilling operations at its well in the Krishna Godavari
basin next month. RIL has always had a dominating presence in petrochemicals, a
downstream area. All that the company needed for complete integration was arefinery. The merger of RPL fills that gap.
Well-timed merger- RPLs 27 mtpa refinery at Jamnagar is Asias largest
refinery and the fifth largest at a single site. It is also highly cost-efficientits
capital cost of Rs 14,250 crore is about 30 per cent less than that of any
comparable refinery set up elsewhere in Asia. The high level of sophistication of
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the unit makes possible greater levels of value-addition and ensures higher
refining margins than most of RPLs peers.
The refinerys huge size and low capital cost gives RPL a substantial edgeover its domestic competitors like IOC, HPCL and BPCL. These companies have
the advantage of their large retail networks, but it wont be long (three years at
most) before RPL has an extensive network of its own.
Given these cost advantages and growth prospects, it made sense for the
group to merge RPL into RIL, which consumes about a third of the formers
output. This makes RIL an even more formidable petrochemical company. It also
aligns its business model with that of its peers like BP-Amoco, ExxonMobil and
Shell, which have integrated upstream (oil exploration and production) and
downstream (petrochemicals) operations. The merged entity will save on sales
tax that RPL currently pays on the output soldestimated at Rs 7,500 croreto
RIL. The merger will also effectively put to rest any controversies regarding
transfer pricing between the two companies.
Strengthening financials- There are other clear benefits that arise from the
merger. The merged entity will have formidable financial muscle which the group
needs to tap into emerging opportunities in a deregulated petroleum sector. It will
also help the company challenge the might of a bigger IOC following its
acquisition of IBP
In the immediate future, RIL will look to use its enhanced financial
strength to bid for the governments stake in BPCL and HPCL, slated for
divestment in June. It is estimated that a buyer would have to shell out around Rs
4,000 crore for a controlling stake in each PSU. It is imperative for Reliance to
grab one of the two oil marketing companies on the divestment block, as this is
its last chance to acquire a readymade distribution network.
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At present, RPL sells almost half of its produce to oil PSUs; the balance is
exported or sold to RIL. It is currently at the mercy of these PSUs to sell its
produce in the domestic market. An established marketing network, like that of
BPCL and HPCL, will enable it to make greater sales in the domestic retail
market (where the margins are higher than in exports)at more favourable terms.
It also has the option to set up its own network, but this will be relatively more
expensivethe cost of setting up a countrywide retail network is estimated at Rs
8,000 croreand time-consuming. Besides, a delay would allow the competition
to steal a march.
Reliance also has ambitious plans for other sectors, among them biotech,
telecom and power, for which it requires enormous amounts of cash. Take the
groups telecom foray, for which it needs around Rs 25,000 crore. Group
company Reliance Infocomin which Reliance has a 45 per cent stakeis setting
up a broadband backbone connecting 186 cities in the country. In telephony,
Reliance, through its 26 per cent subsidiary Reliance Telecom, has licences for 18
basic circles and four cellular circles. The post-merger RILs strong cash flows
will make it far easier to fund these ventures through internal accruals, or new
loans if need be. The proposal to divest 12 per cent of the merged entitys equity
held by Reliance associate companies to overseas investors could help it rake in
around Rs 5,400 crore. This would further improve the companys financial
position.
Advantage to shareholder-
There is a school of thought that believes that RPL shareholders have been given
the short shrift. The swap ratio was set at 1:11one share of RIL for 11 shares of
RPL. On the face of it, the swap ratio seems to favour RIL shareholders. A
valuation on the basis of book value and earnings per share would have meant a
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swap ratio o