M & APart ii

• P/E Ratio & EPS

• If the target company shares are bought at higher P/E ratio than predator company shares, the Predator company’s EPS will fall

• If the target company shares are bought at Lower P/E ratio than predator company shares, the Predator company’s EPS will rise

Valuation of M & A-

• Example 01

• “ A” PLC consider to takeover “B” Ltd.

• “A “decide to exchange their shares with “B” based market value of shares of both companies & “B” Ltd will receive “ A” PLC shares equal to market value of “ B” Ltd shares

• Determine the EPS after merger ( assume no synergy )

1. If estimation of P/E ratio B Ltd is 2

2. If estimation of P/E ratio B Ltd is 4

Company Earnings No of shares P/E ratio

A 5000,000 1000,000 3

B 3000,000 600,000 -

Valuation under M & A- DCF Approach

• Merger is a special type of capital budgeting decision

• Steps:

• Identify growth & profitability assumptions

• Estimate cash flows & terminal value

• Estimate cost of capital

• Decide if acquisition is attractive on the basis of present value

• Decide if acquisition should be financed through cash or exchange of shares

• Evaluate the impact of the merger on EPS and PE ratio

Financing a Merger

• Cash Offer

• What is the maximum price should pay

• Does not cause any dilution of earnings

• Share Exchange

• Determine the exchange ratio

• Need to consider the post-merger value of those shares we’re giving away.

valuefirmNewpayoutfirmTarget a

issuedsharesNewsharesOld

issuedsharesNew

+=a

Example 02

• ABC PLC going to offer take over bid to XYZ PLC

• CEO of ABC believes that combined company has value of $ 1 billion & XYZ can be acquired at $100Mn premium.

• A. if ABC PC offers 15Mn shares of its stocks for exchange for 20Mn shares of XYZ , what is the stock price after merger

• B. How much shares should ABC offer to XYZ where stock offer is equivalent to cash offer above & what is the exchange ratio

Company Market value- Share Outstanding

ABC PLC 600 Million 30 Million

XYZ PLC 200 Million 20 Million

Regulation of takeovers

• Takeover regulation in Sri Lanka

• The Srilankan SEC ( Securities Exchange commission) monitors takeover activities in companies listed in Colombo Stock exchange ( CSE)

• Accordingly takeovers & mergers code of 1995 ( amended 2003) applies

• Code deals with three type of offers

• Voluntary offers

• Partial offers

• Mandatory offers

• Competition Legislation

• Takeover & Mergers may be investigated by competition authorities to ensure that one company cannot dominate the market.

• Consumer affairs authority act of 2003 is the key competition legislation in Srilanka ensure that the sprit of the act is enforced

Post acquisition integration

Inadequate integration will result failures of takeovers

• P F Druker has suggested five golden rules for the process of post acquisition

• Rule 01: Within year, the acquiring company should put top management with relevant skills in place

• Rule 02: The acquiring company must add value to the target

• Rule 03: the acquiring company must show respect to product, management & track record of target

• Rule 04: Ensure there is common core of unity ( tae actions to systems are compatible)

• Rule 05: Strategies should be developed for holding on existing staff

Merging systems

• Degree of integration of two companies information, control & reporting systems is important.

There are two extreme of integration

❑ Complete absorption of the target company

Cultures, operational procedures & organizationalstructures of two companies are to be fused together.

Significant cost reduction is expecting on this approachthrough economics of scale.

❑ The preservation approach

The target company become independent subsidiary ofholding & would be more suitable when merger ofcompanies very different products.

Failure of mergers & takeovers• Takeovers always expect value addition to the shareholders of

Predator

• A KPMG study indicates that 83% of merger deals did not boost shareholder returns.

• Why??

• Strategic plan fails to produce benefits that expected or over optimum about future market conditions & operating synergies

• Poor integration of Management• Inflexibility

• Poor man management

Exit Strategies- Termination of ownership of the company

1. Divestment – disposal of part of its activities or downsizing of thescope of the business

Following are the indicators that mandate the firm to adopt this strategy:

• Continuous negative cash flows from a particular division

• Unable to meet the competition

• Huge divisional losses

• Difficulty in integrating the business within the company

• Better alternatives of investment

• Lack of integration between the divisions

• Lack of technological upgrade due to non-affordability

• Market share is too small

• Legal pressures

.

Other rationale for Corporate Divestures

• Divestment part is performing reasonably well however it is not wellpositioned with in the industry to give long term competitive advantages

Example: GE often divest business that are not among top two orthree in their industry even though they are profitable

• Parent experiencing financial distress & need to raise cash to mitigate this& avoid eventual liquidation

• Poor strategic Fit with new strategy

Types & Characteristics of divestitures

Divesture

Loss of Control divested business

Retain control of divested

business

Sell off- Spin offEquity Crave

outTracking stock

2.Demergers

Opposite of Merger. Splitting up a corporate body in to two or more separate & independence companies

Demergers generate much interest because they bring about a dramaticdownsizing for parent companies. Given the natural emphasis ofcorporations on growth, this may seem counter-intuitive.

2.1 Spin off

New company created whose shares are owned by the shareholders of the original company which is making the distribution of assets.

Businesses wishing to streamline their operations often sell less productive or unrelated subsidiary businesses as spinoffs. For example, a company might spin off one of its mature business units that is experiencing little or no growth so it can focus on a product or service with higher growth prospects.

i.e

• In 2014, Hewlett Packard (HP) To Separate Into Two New Industry-Leading Public Companies-

• Hewlett Packard Enterprise

• HP Inc

• Hewlett Packard Enterprise will define the next generation oftechnology infrastructure, software and services for the New Style of IT

• HP Inc. will be the leading personal systems and printing companydelivering innovations that will empower people to create, interact andinspire like never before

• Strategic step provides each new company with the focus, financialresources and flexibility to adapt quickly to market and customerdynamics while generating long-term value for shareholders

• Highlights:

• Hewlett Packard Enterprise was build upon HP’s leading position in servers, storage,networking, converged systems, services and software as well as its OpenStack Helioncloud platform

• Meg Whitman has become President and Chief Executive Officer of Hewlett PackardEnterprise; Pat Russo to be Chairman of Hewlett Packard Enterprise Board

• HP Inc. the leading personal systems and printing company with a strong roadmap intothe most exciting new technologies like 3D printing and new computing experiences

• Dion Weisler has become President and Chief Executive Officer of HP Inc.; Meg Whitmanto be Chairman of the HP Inc. Board

• Company reiterated fiscal 2014 non-GAAP diluted net earnings per share (EPS) outlook of$3.70 to $3.74 and updates GAAP diluted net EPS outlook to $2.60 to $2.64

• Company issues fiscal 2015 non-GAAP diluted net EPS outlook of $3.83 to $4.03 andGAAP diluted net EPS outlook of $3.23 to $3.43

Whether this Spin off is successful??

• In 2017, after three years from Spin off

• HP Inc. is a better Value Stock than Hewlett Packard Enterprise

• HP’s stronger core markets, better growth figures, and simplerbusiness model all make it a better value play than its enterprisecounterpart.

• What is the reason???

• 1. Faster growing core markets

After the two companies split in late 2015, HP retained the company'sPC, printing, and imaging businesses, while HPE retained its enterprisehardware, software, and services.

At the time, none of those markets looked appealing -- PC sales werestuck in a multi-year slump, printer sales were warning due topaperless workplaces and generic cartridges, and companies werespending less on enterprise hardware, services, and software solutions.

However, the PC market started warming up again this year, supportedby rising demand for premium laptops, convertibles, and other 2-in-1devices. That's why HP's Personal Systems (PC) revenue rose 10%annually to $8.2 billion last quarter. HP's Printing sales still dipped 3%to $4.5 billion, but the company has been diversifying that businesswith mobile printers for smartphones and industrial 3D printers, andexpanding its scale by acquiring Samsung's printing business.

2. Better revenue and earnings growth

• Both HP and HPE use buybacks to boost their earnings.

• Over the past 12 months, HP spent $702 million (19% of its free cashflow) on buybacks. HPE spent $1.83 billion on buybacks, whichexceeded its free cash flow and was partly funded by debt.

• Analysts currently expect HP's earnings to rise 1% this year and 5%next year. Again, those numbers aren't great, but they're much betterthan HPE's projected earnings declines of 23% this year and 8% nextyear.

• HP's steady earnings growth enables it to pay a forward dividendyield of 2.8%, which is supported by a payout ratio of 33%. That'smore than double HPE's forward yield of 1.4%, which is supported bya lower payout ratio of 13%.

3. Fewer moving parts• company with fewer moving parts, because they're easier to

understand. HP's core PC and Printer businesses are clear cut, andthe market trends are easy to follow. HPE's business is more complexand murky, and CEO Meg Whitman seems to be channeling IBM bycutting jobs, divesting businesses, and performing complex spin-mergers to boost its bottom line growth.

• Prior to the split, HPE shuttered its public cloud service to focus onthe less-competitive on-site and hybrid cloud markets. It then agreedto spin-off and merge its struggling IT services unit with ComputerScience Corp. in an $8.5 billion deal, then agreed to spin-off of its"non-core" application delivery management, big data, and enterprisesecurity businesses to Micro Focus International in another $8.8billion deal.

HP Spin – Merger to Form DXC Technology• On April 1, 2017, Hewlett Packard Enterprise completed the spin-

merger of its Enterprise Service segment to form DXC Technology(NYSE: DXC; $67.95; Market Capitalization: $19.3 billion).

• Distribution and Ownership

• Shareholders of CSC as of record received one share of DXCfor each share of CSC. HPE shareholders received 0.086shares of DXC for each share of HPE held as of March 20,2017, the record date.

• Post merger, legacy shareholders of CSC own 49.9% stake inDXC and shareholders of HPE own 50.1% stake in DXC.

• HPE shareholders retain stake in HPE as well as hold approximately50.1% interest in DXC. CSC shareholders hold the remaining 49.9%ownership.

Deal Rationale

• The strategic combination of HPE and CSC proffer benefits to both ITgiants, with DXC gaining from scale, technological proficiency,versatility, and skilled management. DXC is anticipated to have annualrevenues of $26.0 billion, 85 delivery centers and 95 data centersservicing over 5,000 clients speckled across 70 countries globally, andcost-synergies of about $1.0 billion in the very first year. Given only15% overlap in client accounts of both companies despite substantialsimilarities in operation, the deal will expand customer footprint androom to innovate.

• The sleeker HPE, on the other hand, will benefit from a more taperedfocus on hardware sales and equity stake in the new company, valuedat over $9.5 billion in a combination of 50% ownership stake, cashdividend of $1.5 billion, and $2.5 billion of debt and other liabilities.

• 3. Going Private

Public company goes public means, small group of individuals including exiting shareholders & managers with or without support of financial institution buys all of the company shares.

Advantages of going for private

• Saving of cost of listing requirement

• Company less vulnerable to hostile takeovers bids

• MGT can focus on long-term needs of the business rather than short term expectations of shareholders

• Shareholders are likely to be closer to management in private company

Management Buyout - MBO

• MBO is purchase of business from its exiting owners by members ofthe management team, generally association with financing institution

• MBOs are favored exit strategies for large corporations who wish topursue the sale of divisions that are not part of their core business, orby private businesses where the owners wish to retire.

Why MBO• The subsidiary may be different to the mainstream of group & no

longer strategic Fit

• Group wish to sell loss making company

• The parent need to make quick cash

• The best price may coming from a small management group

• It will probably get better corporation from the management & employees if subsidiary sales is MBO