Chapter III-Merger & Acquisition
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Transcript of Chapter III-Merger & Acquisition
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M&A
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Merger
Fusion of two or more companies
Through direct acquisition
By one enterprise The net assets of another enterprise
Eg., Vodafone International acquisition of
Hutchison Whampoa Bharti airtel acquisition of Zain Telecom
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Takeover
Any transaction
In which an acquiring company
Acquires all or part of the shares of
Target company
In take overs, the sellers management
Is an unwilling partner
To the combination of corporate entities
Eg., Manu Chabarias takeover of Shaw WallaceCompany
Lord Swaraj Pauls attempted takeover of Escorts Ltd
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Amalgamations
The combination of more than one companies
Into one
The amalgamated companies lose their legal
existence And form into a new ,separate legal entity
Eg.,
Hindustan Computers Limited , Indian software
Company Limited Amalgamated into a new company called HCL
Limited
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Horizontal Merger
Joining of two or more firms
In the same stage of
production/distribution/area of business
Eg., bharti airtel
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Vertical Merger
Joining of two or more firms
Involved in different stages of
production/distribution
Eg., reliance industries merger with reliance
petroleum
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Conglomerate Merger
Joining of two enterprises
Engaged in different ,unrelated lines of
business activity
Eg.,
ITC taking over Bhadrachalam paper products
Ltd
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Merits and Demerits
The principal reason for a merger is to
increase the value of shares
Of the acquiring company
Besides operating economies,
elimination of duplicate efforts
Synergy etc.,
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Demerits
Increased risk due to venturing into unrelated
area
Loss of focus
Drain of acquiring companys resources and
management time
Unrealistic expectations
Legal hurdles
Cultural incompatibilities etc.,
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Legislation
IT ACT,1961
RBI ACT,1934
FEMA,1999 Competition Act,2000
MRTP ACT,1969
Companies Act,1956
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Benefits-Costs Approach
Two companies
Acquiring Company A Ltd
Target Company T Ltd
PV of A Ltd = 200 L
PV of T Ltd = 50 L
A ltd offers to purchase/acquire T Ltd for 60 L
? Expected value ? Benefit to T Ltd
? Cost to A Ltd
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PVA = 200 lakhs
PVT= 50 lakhs
Expected Value = PVA+T = 300 lakhs Cash payout for T = 60 lakhs
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The benefit of merger
= Benefit = PVAT (PA+PT)
Cost of merger = cash payment for acquiring Tless the PVT as a separate entity
Thus
Cost = Cash - PVT
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Benefits = PVA+T(PVA + PVT)
= 3 00 (200 +50)
= 50 lakhs
Cost = cash - PVT
= 60 50 = 10 lakhs
NPVA = Benefit Cost = 50 -10 = 40 lakhs
NPVT = cost = 10 lakhs
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NPV of merger from the point of Acquirer A Ltd isdifference between benefit and cost
NPVA = Benefit Cost =
(PVAT (PVA+PVB) ) Cash + PVT NPV of merger from the point of target company
T is simply the cost of merger from the acquirerfirm As view
Hence
NPV to T = Cash PV T
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Sec 391-394 of Companies Act,1956
Chapter V ( 390 to 396A)
Company Court Rules, 1959 SAST,1997
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Merger
Includes consolidation, amalgamation,absorption
Acquisition includes take over
Change in control
Agreement with persons in control
Subscribing to new shares
Stock market purchase
Open offer
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Takeover
Hostile acquisition
AS14amalgamation by merger /purchase
Merger Reverse merger
Horizontal
Vertical conglomerate
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Merger Motives
Operating economies
Diversification
Increasing EPS Financial synergy
Corporate control
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Company perpetual succession and commonseal
Free transferability
SAST applies to listed companies Applies to substantial acquisition
Of shares /voting rights /control
Global acquisition are also covered
PAC common objective Self-declaratory mechanism
Form 24A
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Shareholding limit Procedure
New upto 4.9% Nil
New-5% -upto 25% Disclosure to company
Existing-25% upto 55% Open offer
upto 5% pa Cal Year allowedcreepingExisting-holding more than 25% 55% and aboveopen offer
Share holding >75% Open offer
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Open offer for 25% of capital of company frompublic share holders
No obligation to purchase 25% from public
Only offer needs to be made MByes
Code applies when you make your intention
To acquire 25% or more shares
Public announcement within 4 days Letter of offer ~~ prospectus
Vetting - yes
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Offer price highestlast 6 months /last 2 weeksvolume weighted average price
Acceptance on pro-rata basis
MB to give certificate Bank guarantee for open offer amount
2 triggers for open offer-25% and 55%
Regulation 10&11acquisition of shares
Regulation 12 controlwhen you acquire shares However, regulation 12 does NOT over rule
R10&11
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Disclosure on pledging of shares yes
SEBI empowered to grant exemption fromtakeover code
Increase in share holding or voting rights obuy-back of shares regulated only under R 11and NOT u/R 12
However, promoter share holding can notexceed 75%
Exemption applicable under R4
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Takeovers:
A device to punish weak managements
And protect interest of small share holders(
Pickens T.Boons, Jr. 1988)
Takeover tend to shatter employee morale
and help raiders to make a fast buck(Peter
F.Drucker)
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Merger :
an arrangement
Whereby
Assets of two or more companies
Become vested in or under the control of one company
Transferor company is dissolved without winding-up
Section 35,43,47(vii),49,72 of Income Tax Act,1961
MRTP Not involved
Approval of CCI after certain limits
SICA,1985-yes
Sec 25 Companies-Yes
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Legal Aspects
Section 391 -394
Scheme of compromise or arrangement
Application to company court for directions to
hold meetings Special resolution
Court sanction
Court order w.e.f date of filing with ROC Appealable
Approval of FI-yes
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Court discretion
scheme must be fair and equitable
Scheme in good faith not contrary to public interest
Not a device to evade law
Approval of RBI in case of issue of shares / options to NRI
Notice to central government through RD Transferor company also to comply with Chapter V
OLs report-yes
Sec 396 special powers to central government
To order merger in public interest
(under exclusion clause of section 394,395)
RBI nod-yes-for banking companies
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Tax Aspects
M&A NOT defined under Companies Act,1956
Amalgamation defined defined u/s 2(1B) of ITACT,1961
For a merger to qualify as an amalgamation Under IT Act,
Vesting of property
Vesting of liabilities 3/4th of share holders become shareholders of
amalgamated company
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Carry-forward and set-off of accumulated lossesyes
Sec 2(47),IT Act-Transfer defined
Transfer to include sale, exchange or relinquishment ofasset
Transfer between 2 foreign companies NOT transferfromAY 1993-94
Transfer does not include transfer of shares
If transfer consideration is shares (Sec 47(vii))
Shareholder NOT liable to Capital Gains Tax
As amalgamation does not include exchange orrelinquishment of assets
(Rasik Lal Vs Manak Lal ( 1975) 95 (ITR) 656)
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Issue of Bonds, Debentures in lieu of
shares
If any shareholder is allotted bonds,debentures , exemption u/s 47(vii) is NOTapplicable
(Gautam Sarabhai Trust (1988) 173 (ITR)216(Guj))
No separate filing of NOTICE for increase in
authorised share capital u/s 97 of CompaniesAct
Or fees u/schedule X (Sec 611)
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Exemption
Areva T&D India Limited (2009) 138 Comp
Cas 834 ,Calcutta HC
Slump saleS 2(42C) of IT Act,1961
Doughty Vs CCDT
Sarabhai M. Chemicals (p)Ltd vs P M Mittal
(126 ITR)
Tax at book value ,at slump priceCG
Killic Nixon & CO Vs CIT (49 ITR 244)
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Stamp duty
rates of stamp duty : entry 63, list II , seventh
schedule, Indian Stamps Act,1899
Court order is an instrument and liable to
stamp duty
Stamp duty on asset liabilities = value of
shares allotted
However, no stamp duty on order of BIFR
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Advantages of M&A
The principal reason is to increase the value of
the shares of the acquiring company
Other advantages could be operating
economies, elimination of duplicate efforts,
synergy etc.,
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Disadvantages of M&A
Increased risk due to venturing into unrelatedarea
Loss of focus
Drain of acquiring companys resources
Wastage of management time
Unrealistic expectations
Legal hurdles
Cultural incompatibilities
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Determinants of Exchange Ratio
Earnings approach
Market Value approach
Book Value Approach
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Earnings Approach
Item A Limited T Limited
PAT 60 L INR 12 LNo.of shares 6 L 3 L
EPS 10 Rs/share 4 Rs/Share
MPS 75 Rs/Share 24 Rs/share
P/E 7.5 6
Acquirer Company A Ltd acquires Target Company T Ltd
Assumptions : NO change in Profit after Tax ( PAT) after amalgamation
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Questions:
What is the effect on the EPS of the mergedcompany
Options:
A) offer of Rs. 30 / share of T limited b) Offer of Rs. 50 per share of T Limited
Payment will be made as shares of A ltd
No cash payment
Assume NO synergy
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Option A
Exchange ratio = Offer Price T / MPSA
=30/75 = 0.4
In other words, A Ltd will give 0.4 shares for
every ONE share of T Ltd So, total number of shares to be issued to T
Ltd by A ltd= 300000*0.4 = 120000 shares of A
Ltd Revised share capital of A limited = 6 L + 1.2 =
7.2 L shares
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EPS of amalgamated company = Total PAT /
Total shares
= 7200000/720000 = 10 Rs/share
Change in EPS of A ltd AFTER amalgamation =
10 Rs/share ( no change)
Revised EPS of former T Limited = 10*0.4 = 4 =
EPS * ER = (no change)
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Option B
A ltd offers Rs. 50/share to T Ltd Exchange ratio = 50/75 =0.67
No. of shares to be issued t T Limited by A Ltd
= 300000*0.67 = 200000 shares
EPS of amalgamated company = Total PAT /Total shares=720000/800000 = 9 Rs/share
So, drop in EPS of A ltd from Rs 10 per share to Rs. 9 Rs/share
revised EPS = 9 Rs/share
Exchange Ratio = 0.67
EPS of former shareholders of T limited
= Exchange Ratio * Revised EPS of Acquiring Company
= 9 * 0.67 = Rs. 6 per share ( up from Rs 4 per share)
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Observations
Change both upward and downward of EPS is
possible
When P/E of target company is greater than
P/E of acquiring company,
There is a drop in EPS
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Situation A
Remarks
Offer price to T Ltd Rs 30 per share
EPS of T ltd = Rs 4 per share
P/E of T ltd = 30/4 = 7.5
Same as P/E of A ltd before merger
So, no change in EPS of A ltd after merger
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Situation B
Remarks
P/E offered for merger of T ltd = 50/4 = 12.5
P/E of A ltd before merger = 7.5
Drop in EPS of A Ltd after merger to Rs 9 per
share from Rs. 10 from share
Increase in EPS of former share holders of T
Ltd from RS . 4 per share to Rs. 6 per share
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Issue
The assumption that
PAT of amalgamated company
Is sum of A ltd and T limited
Is normally NOT true
There is always synergy +ve orve
Why bother with an energy sapping M&Awhen there is NO synergy ?
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Market Value Approach
Exchange ratio MPS =MPST /MPSA MPSA = Rs.50 MPST = Rs. 25
So, exchange ratio = 25/50
=0.50
Ie., issue of one share of A ltd for every TWO shares of T Ltd
If T Ltd share capital is 10000 shares, it will get 5000 shares of A Limited
Issues:
MPS is available ONLY for listed companies
The shares of even a listed company may not be actively traded Ever changing MPS of the shares
Manipulation of EPS
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Book Value Approach
Exchange Ration if a function of BV
BV = Net worth / No. of equity shares
ER = BVt/ BV
A
Issues :
Net worth is subject to manipulation
No weightage given to earnings capacity ofthe firm
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Break Even Exchange Ratio (BEER)
The number of shares offered by the acquiring
company
In exchange foe ONE share of the target
company
At which there would be neither increase or
decrease
In the value of the shareholders of the
relevant company
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At break even exchange ratio, there is neitherappreciation or depreciation
In the market value of the acquiring company
At the minimum acceptable exchange ratio ofthe target company, ,market price of theirholdings in the acquiring company
Will be equal to the market price of theirholding
BEFORE the merger
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At BEER,
The market price before and after merger
Will be same for the target company
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BEER
[(PATA + PAT T)(1+s)] -PATA ERA = ----------------------------------
EPSA * NT
Where
PATA = Profit after tax of acquiring company
PATB = Profit after tax of target company
s = synergy effect as % NT is the number of shares outstanding of Target
Company T
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BEER
EPST * NA BEERT = ----------------------------------
[(PATA + PAT T)(1+s)] -PATT
Where
EPST = Earnings per share of Target Company
PATA = Profit after tax of acquiring company
PATB = Profit after tax of target company
s = synergy effect as %
NA is the number of shares outstanding of AcquiringCompany A
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example
Item A Ltd T Ltd
PAT 2000000 600000
Shares o/s 1000000 600000
EPS 2 Rs/share 1 Rs/share
MPS 20 8P/E 10 8
Growth in EPS 8% 6%
Synergy effect of merger 10%
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[(PATA + PAT T)(1+s)] -PATA
ERA = ----------------------------------
EPSA * NT
[(2000000+600000)*1.1] (2000000)
= ----------------------------------
2*600000
= 0.717
Ie., EPSA will be same at pre/post merger ar a ER of 0.717shares of A Ltd for every share of T Ltd
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EPST * NA
ERT = ----------------------------------
[(PATA + PAT T)(1+s)]PATT
1* 1000000
ERT = ----------------------------------
[(2000000+600000)*1.1] -600000
= 0.442
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ERA = 0.717 = 600000*0.717 = 430000 shares
of acquiring company A
ERT = 0.442
Revised PAT , post merger =
(2000000+600000)*1.1= 2860000
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Revised number of shares =1000000+430000
= 1430000 shares of A
EPSA = combined = 28600000 / 1430000 = 2
RS/share
Pre-merger EPS of acquiring firm A =
2000000/1000000 = 2 RS/share
EPST = 860000/430000 = 2 RS/share
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@0.442 ER, number of shares of T Ltd in A ltd
= 600000*0.442 = 2,65,000 shares f A ltd
So, EPST = 2860000 * 265000/1265000 = Rs. 1
per share ( no change)
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M&A Problem # 1
X Company Limited ( the acquiring company)
proposes to acquire the target company Y
Company Limited
The following information is givenItem X Co Ltd Y Co Ltd
PAT 200000 500000
No.of shares 100000 250000
EPS 2 2 Rs/sh
MPS 100 40 Rs/sh
P/E 50 20
MV 10000000 10000000
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Solution
Combined PAT = 7,00,000 Rs
New shares to be issued to holders of shares of Yco ;ltd = 250000*40/100 = 1,00,000 shares of X
ltd Revised share capital of X ltd =100000+100000 =
200000 shares
Combined EPS = 700000/200000=3.5 RS/share
Combined MV = 2,00,00,000
Combined P/E = 100/3.5 = 28.57
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Increase in EPS of shareholders of X Ltd = 3.5-2
= 1.5 Rs/share
Decrease in EPS for (erstwhile)share holders of
Y Ltd = revised EPS * exchange ratio = 3.5*0.4= 1.4 Rs/share ( from 2 RS/share) = 0.6
Rs/share (decrease)
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M&A = # 2
Alpha wants to acquire Beta Limited
Option A) Offer by Alpha at 5 times of betas
earnings
Option B) counter offer by beta to acquire
alpha at 20 times of alphas earnings
THE following additional information is given:
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Alpha & beta
Item Alpha Ltd Beta Ltd
EPS 2 Rs/share 2
MPS 40 Rs/share 20
P/E 20 10
No.of shares 4,00,000 4,00,000PAT 8,00,00 8,00,000
Total MV 1,60,00,000 80,00,000
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Alpha & Beta Option A
ER = exchange Ratio = 5 times of Betasearnings = 10 Rs/share of beta
So, exchange ratio = 10/40 = offer price/MPS
of alpha = 0.25 shares of alpha for every shareof Beta Ltd
So, total number of shares (of alpha) to beissued to beta limited = 400000*0.25 =1,00,000 shares of alpha ltd
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Revised share capital of alpha ltd = 4,00,000 +1,00,000 = 5,00,000 shares (of alpha)
Revised EPS of amalgamated company = total PAT/ Total shares = 16,00,000/5,00,000 = 3.2
Rs/share change in EPS of alpha limited after
amalgamation =1.2 ( 3.2 from 2.0) rs/share
REVISED EPS of shareholders of (former beta ltd)
= ER * Revised EPS = 3.2*0.25 = 0.8 Rs/share Change in EPS of shareholders of (former beta
ltd) = 1.2 Rs/share (from 2 to 0.8)
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Alpha & beta Option B
Beta ltd is the acquirer Exchange ratio = 20 times of alphas earnings =
Rs. 40 /share of alpha
no of shares of alpha to beta limited = 40/20 =2 shares of beta ltd for every share of alpha ltd
number of shares of beta limited to be offeredto alpha limited = 400000*2 = 8,00,000 shares ofbeta limited ( alpha goes out of business)
revised share capital of beta limited =400000+800000=12,00,000 shares
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Combined PAT (after merger) = 16,00,000 Rs
revised/combined EPS =16,00,000/12,00,00 = 1.33 Rs/share
Revised EPS of (former share holders of alphalimited) = ER * revised EPS = 2*1.33 = 2.66
change in EPS of (former share holders of
alpha limited) = 2.66-2 =0.6 RS/share change in EPS of the acquiring firm beta
limited = 1.33 -2 = (-0.67) Rs/share
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Alpha & Beta synergy effect
Proposal A
Merger benefit = 2,00,000 RS
combined PAT = 18,00,000
combined share capital = 5,00,000 shares
Change in EPS of alpha limited after merger of
beta limited =18,00,000/5,00,000 = 3.6 Rs/share
Change in EPS of (former beta limited) = 0.25*3.6
= 0.90 Rs/share ( down from 2.00 Rs/share)
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