Merger, Acquisition and Restructuring

Definition: Merger or Amalgamation

“A merger is said to occur when two or more companies combine into one company”

“In merger there is a compete amalgamation of the assets and liabilities as well as
share holders‟ interest and business of the merger companies.”

Section 2 (1-A) of the Income Tax Act, 1961 defines amalgamation as the merger of one or
more companies (calling merging or amalgamating company) with another company
(merged company) or the merger of two or more companies to form a new company in such
a way that all assets and liabilities of the merging companies will become assets and
liabilities of the merged company.

Merger/Amalgamation can take place in any of below mentioned two manners/methods:

 Merger through absorption
 Merger through consolidation

1.Merger through Absorption: Absorption is a combination of two or more companies

into an existing company. All companies except one company
lose their identity in a merger through absorption. eg. Absorption
of Tata Fertilizers Ltd. by Tata Chemicals Ltd. here the Tata
Chemicals Ltd (acquiring company) survived after merger while
Tata Fertilizers Ltd. (an acquired company) ceased to exist.
2. Merger through Consolidation: Consolidation is a combination of two or more
Companies into a new company. In this form of merger, all
companies are legally dissolved and a new entity is created. eg.
Merger /Amalgamation of Hindustan Computer Ltd., Hindustan
Instruments Ltd., Indian Software Company Ltd. and Indian
Reprographics Ltd. in 1986 to an entirely new company called
HCL Ltd.

FORMS OF MERGER: There are three major forms of merger namely: Horizontal
Merger, Vertical Merger and Conglomerate Merger

1.Horizontal Merger:
 This is a combination of two or more firms in similar type of production, distribution or
area of business.
 eg. Combination of two Book Publishers or two Biscuit Manufacturers.
 Mainly it is done to gain a dominant market share.
2. Vertical Merger:
 This is a combination of two or more firms involved in different stages of production
or distribution.
 eg. TV Manufacturing Company merges with TV Marketing Company.
  Vertical merger may take the form of forward or backward merger.
 When a company merges with supplier of material it is called „backward merger‟
 When a company merges with a distributor it is called as „forward merger‟

3. Conglomerate Merger:
 This is a combination of firms engaged in unrelated lines of business activity.
 An example would be cement manufacturing company merges with fertilizer
manufacturing company or merge with electronic product manufacturer.

MOTIVES BEHIND MERGER

or
BENEFITS OF MERGER AND ACQUISITON

There are number of reasons attributed for occurrence of merger and acquisition:

For example:
 Reduced competition or limited competition
 Utilize untapped market (uncovered)
 Enhance the profitability
 Achieve the diversification
 To gain economies of scale
 Displace or replace existing management
 To enhance or accelerate growth
 Enhance the profitability through cost reduction
 Reducing tax liability because of the provision of setting off accumulated losses or
sick unit against profit of another company.

Detailed description of motive and benefit of merger:

1. Enhance Growth or Accelerated Growth:

 Growth is essential for sustaining the viability and dynamism and value
enhancing capacity of a company.
 A growth oriented company not only attracts the most talented executives but
it would also be able to retain them.
 This helps to increase managerial effectiveness other things remaining the
same, the growth leads to higher profit and increased shareholder value.
 A company can achieve its growth objective by:
i) Expanding its existing market or
ii) Entering in a new market.
 A company may expand or diversify its market internally and externally. If the
company cannot grow internally due to lack of managerial or physical
resources it can grow externally by combining its operations with other
company/ies through merger and acquisition.

2. Enhanced Profitability:
 The combination of two or more companies may result in more than the average
profitability due to cost reduction and efficient utilization of resources.

This may happen because of following reasons:

i) Economies of scale
ii) Operating economies
iii) Synergy

Economies of scale:
It arises when increase in the volume of production leads to reduction in the cost of
production per unit.
This is because with merger, fixed costs are distributed over a large volume of
production causing the unit cost of production to decline

Operating Economies:
It arises because a combination of two or more firms may result in cost reduction due
to operating economies.
In other words a combined firm may avoid or reduce overlapping function and
consolidate its management function such as manufacturing, marketing, R&D etc. are
thus reduces operating cost.
For example, a combined firm may eliminate duplicate channels of distribution.

Synergy:
It implies a situation where the combined firm is more valuable than the sum of
individual combining firms.
It is defined as 2+2=5 phenomenon.
Synergy refers to benefits other than those related to economies of scale.
Operating economies are one form of synergy benefit but apart from operating
economies, synergy may also arise from enhanced managerial capabilities, creativity,
innovativeness, R&D, market coverage capacity due to complementarities of
resources and skills and a widened horizon of opportunities.

3. Diversification of Risk:

 It implies growth through the combination of firms in unrelated business such

mergers are called conglomerate merger.
 It is difficult to justify conglomerate merger on the ground of economies. It
does not help to strengthen the horizontal or vertical synergies.
 The risk will be reduced if the operation of the combining firms are negatively
correlated.

4. Reduction in Tax Liability:

 A profitable company can buy a loss making unit to take the tax saving
benefits.
 In the US and many other countries rules are in place to limit an ability of
profitable companies to shop for loss making companies limiting the tax
motives of an acquiring company or firm.
 5. Gain in Market Share:
 Merger and Acquisition can prove to be really beneficial to the companies
when they are in tough (perfect or without monopoly) market competition.
 If the company which is suffering from various problems in the market and is
not able to overcome difficulties it can go for an acquisition deal.
 If the company which has a strong market presence buys out the weak firm
than more competitive and cost effective company can be generated.
 Here, the target company benefits as it gets out of difficult situation and after
being acquired by the large firm, the joint company accumulates larger market
share.

6. Financial Benefits:
 There are many ways in which a merger can result into financial benefits.
 Various ways through which a merger may help in “
Eliminating financial constraints
Deploying surplus cash
Enhancing debt capacity
Lowering the financial cost.

7. Increases Market Power:

 A merger can increase the market share of merged firm and thus, increases
market power.
 Improved market shares increases the profitability of the firm due to
economies of scale.
 The bargaining power of the firm vis-à-vis labour, supplier and buyer is also
enhanced.
 The merged firm can also exploit technological break-through against
obsolescence and price wars.
 Thus, by limiting competition, the merged firm can earn super-normal profit
and strategically employ the surplus funds in further consolidate its position
and improve its market power.

(A) Plausible Reasons of Merger:

1. Strategic Benefits
2. Eliminates Competition
Merger eliminates competition or lowers it.
3. Economies of Scale

4. Economies of Scope
Use of specific set of skills or assets that it possesses the widen scope of activities.

5. Economies of Vertical Integration

When companies engaged at different stages of production are merged, economies
of vertical integration may be realized.
For example, if TV manufacturer is merged with TV marketing company that, it may
improve coordination and control the cost, so profit will be higher.
 6. Complimentary Resources
If two firms have complementary resources it may make sense for them to merge.
For example,
A small firm with an innovative product may need the engineering capability and
marketing skills. With the merger of two firms it may be possible to successful
manufacturing and marketing of the innovative product.

7. Tax Benefits
8. Utilization of Surplus Funds
9. Managerial Effectiveness
Increase in managerial effectiveness may occur, if the existing management team
which is performing poorly, replaced by more effective skilled management team.

(B) Dubious / Doubtful Reasons for Merger:

1. Diversification of Risk
2. Lower Financing Cost
3. Earning Growth

Cost and Benefits of Merger:

- When firm A acquired firm B, A is making a capital investment decision and firm B
making a capital divestment decision.
- So, in case of merger it is vital to find a net present value of firm A and Firm B.
- To calculate NPV of firm A we have to identify the benefits and cost of merger.
- Benefit of merger is the difference between the PV of combined entity [PV (AB) ] and
the PV of the two entities if they remain separate

i.e. [PV (A) + PV (B) ]

hence,

Benefit = [PV (AB) ] - [PV (A) + PV (B) ]

- The cost of the merger from the view point of firm A assuming that compensation to
firm B is paid in cash, is equal to the cash payment made for acquiring firm B less the
PV of firm B as a separate entity.

Hence,

Cost (for Firm A ) = Cash payment - PV (B)

- The NPV of merger from the view point of firm A is the difference between benefit
and cost.
 NPV(for Firm A) = Benefit – Cost

= [PV (AB) ] - [PV (A) + PV (B) ] – [Cash payment - PV (B) ]

---------------------------------- --------------------------------
benefit cost
= PV (AB) - PV (A) - PV (B) – Cash payment + PV (B)

= PV (AB) - PV (A) – Cash payment

The NPV of merger from the view point of firm B is simply the cost of firm A. hence,

NPV (for firm B) = Cash Received - PV (B)

Mechanics of a Merger / Process:

While evaluating a merger proposal, one should be clear in mind about the following
legal and tax consideration:

A) Legal Procedures:
Companies Act 1956, contains the provision for merger or amalgamation normally
which involves the following steps:

i) Permisision for Merger:

Two or more companies can be merged only when merger is permitted under
their MOA also, their acquiring company should have permission in its object
clause to carry on the business of acquired company.

ii) Information to the Stock Exchange:

The acquiring and acquired company should inform the stock exchange when
they have decided about the merger.

iii) Approval of BOD:

iv) Application in the high court:

An application for approving the draft merger proposal duly approved by the BOD
of the individual company should be made to high court.
The high court would arrange a meeting of the shareholders and creditors to
approve the proposal. The notice of such meeting should be sent them at least in
21 days in advance.

v) Shareholders and Creditors Meeting:

The individual companies should hold separate meeting of their shareholders for
approving the proposed merger scheme.
At least 75% of shareholders and creditors in separate meetings voting in person
or by proxy must accord approval to the scheme.
 vi) A Sanction by the High Court:
After the approval of shareholders and creditors, on the petition of the company,
the high court will pass an order sanctioning the merger scheme, after it is
satisfied that merger scheme is fair and reasonable.

vii) Filing of the Court Order:

After the court order, certified true copies of the same will be filed with the
Registrar of the Comapanies.

viii) Transfer of Assets and Liabilities:

The assets and liabilities of the acquired company will be transferred to the
acquiring company in accordance with the scheme with effect from the specified
date.

ix) Payment by Cash or Securities:

As per the proposal, the acquiring company will exchange shares and
debentures or pay cash for the shares and debentures of the acquired company.
The securities will be listed on stock exchange.

(B) Tax Aspects:

- There are important tax implications of merger. A special mention must be made of a
tax provision which enables to acquired company to carry forward accumulated
losses and unabsorbed depreciation of the acquiring company in certain cases.
- Following deduction to the extent available to the acquiring company and remaining
unabsorbed and unfulfilled will be available to the acquired company.
- Capital expenditure of scientific resources
- Expenditure on acquisition of patent or copy-right.
- Merger with preliminary expenses.
- Carry forward losses and unabsorbed depreciation of acquired company
Acquisition:

Acquisition may be defined as “An act of acquiring effective control over assets or
management of a company by another company without any combination of business”.

A substantial acquisition occurs when an acquiring firm acquires substantial quantity of

shares or voting rights of the target company.

Thus, in an acquisition, two or more companies remain independent separate legal entity
but there may be changes in the control of the companies.

Takeover occurs when the acquiring firm takes over the control of the target firm.

Holding Company: A company can obtain the status of holding company by acquiring
shares of other company.

A holding company is a company that holds more than half of the nominal value of equity
capital of another company or firm called subsidiary company.

Both holding and subsidiary companies retain their separate legal entities and maintain their
separate books of account.

A. Financing Merger or Acquisition:

Cash or exchange of shares or combination of cash, shares and debt can finance a merger/
acquisition. The means of financing may change the debt-equity mix of the combined or
acquiring company after the merger.

1.Cash offer:
- A cash offer is a straight forward mean of financing a merger.
- It does not cause any dilution in the EPS (Earning per Share) and the ownership of
the existing shareholders of the acquiring company.
- The shareholders of the target company get cash for selling their shares to the
acquiring company.

2. Share Exchange/offer:
- A share exchange offer will result into sharing of ownership of the acquiring company
between its existing shareholders and new shareholders (shareholders of the
acquired firm).
- The earnings and benefits would also be shared between two groups of
shareholders.
- The net benefit that accrue to each group of shareholders would depend on the
exchange ratio in terms of the market price of the shares of acquired firm and the
acquiring firm.
- Exchange Ratio:
- Exchange Ratio is determined in terms of market price of the shares of
acquiring firm and acquired company/ies. It is defined as the number of shares the
acquiring firm is willing to give in exchange for one share of the target firm.
- The offer is expressed in the form of exchange ratio.
- For example an exchange ratio of 0.5 is that the acquiring firm is willing to give its
half share for every share of the target firm.
-
Share price of acquired firm/ target firm
Share Exchange Ratio = --------------------------------------------------------------
Share price of acquiring firm

- The commonly used basis for determining the exchange ratio are EPS, market price
per share, book value per share and discounted cash flow value per share.

-
Firm Value as per DCF – All debts of the firm
- DCF Value per Share = ---------------------------------------------------------------------
Number of Equity Shares

(DCF = Discounted Cash Flow)

B. Leveraged Buy-out (LBO):

- The LBO is an acquisition of a company in which the acquisition is substantially

financed through debt.
- LBO involves transfer of ownership consummated mainly with debt.
- When the managers buy their company from its owners employing debt the LBO is
called „Management Buyout‟ (MBO).

C. Takeover:
- Takeover implies acquisition of controlling interest of another company.
- It does not need dissolution of the company whose shares are being acquired.
- It simply means change of controlling interest in a company through the acquisition of
shares by another company.
- There are three forms of takeover:
1. Negotiated/Friendly Takeover:
This type of takeover is organized by its incumbent management with a
view to parting with the control of management to another group through
negotiation.
The terms and conditions of the takeover are mutually settled by both the
groups by sitting together.
2. Open Market / Hostile Takeover:
It is referred to as the „raid‟ on the company.
In order to take over the management of or acquiring the controlling
interest of target company, a person or group of persons acquires shares
from the open market, financial institutions, mutual funds or willing
shareholders at the price higher than the prevailing market price.
3. Bail out Takeover (Purchase Interest):
When a profit earning company takes over a financially sick company to
bail it out, it is known as a bail out takeover.
 Bail out takeover is a takeover of a financially sick company by a profitable
company.
Generally such a takeover is in pursuance of schemes of rehabilitation
approved by public financial institutions and scheduled banks.

D. Business Alliances:

Different forms of business alliances are :

1. Joint Venture
2. Strategic Alliances
3. Equity Partnership
4. Licensing
5. Franchising Alliances
6. Network Alliances

1. Joint Venture:
A joint venture is set up as a legal entity in which two or more separate organisations
participate.
The JV agreement spells out how ownership, operational responsibility and financial
risk and reward will be shared by the co operating members.
Needless to add, each members preserves its own corporate identity and autonomy.
2. Strategic Alliance:
It is a co-operative relationship like joint venture
However, it does not result in the creation of separate legal entity.
A Strategic Alliance may involve an agreement to transfer technology, provide
research and development services or grant marketing rights.
A strategic alliance may be precursor to a joint venture or even an acquisition.
3. Equity Partnership:
Besides having the characteristics of a strategic alliance, an equity partnership also
involves one party taking a minority equity stake in the other party.
4. Licensing:
There are two popular types of licensing.
The first type involves licensing a specific technology, product or process.
The second type involves licensing a trade mark or copy right.
5. Franchising Alliance
A firm may grant rights to sell goods and services to multiple licensees operating in
different geographical locations.
6. Network Alliance:
A network alliance is a web of interconnecting alliances among companies that often
transcends national and industrial boundaries.
Under such arrangement two companies may collaborate in one market but compete
in another.
Such alliances are common in multimedia, computer, airline and telecommunication
industries.

E. Divestiture / Divestment:
- Meaning: Divestment involves the sale of company‟s assets, product lines, divisions
or brands to the outsiders.
 - It is reverse of acquisition.
- Company uses divestment as a mean of restructuring and consolidating their
business for creating more value of shareholders.
- In divestment, the selling company intends to create more value for shareholders by
selling the part of business at higher price than the current price.

Motives for Divestment:

1. Strategic Change:
Due to the economic and competitive changes a company may change its product
market strategy. It might like to concentrate its energy to certain types of business
where it has more competence and competitive advantage. Hence, it may sell a
business that more fits with the new strategy.
2. Selling Cash Cows:
Some part of the company‟s business might have reached saturation so company
might sell such kind of business which is at the maturity stage and realize cash flow.
The resulting cash flow will be applied to the more profitable business division.
3. Disposal of Unprofitable Business:
Unprofitable business is drain for the company‟s resources. For a company it could
be more profitable to sell such kind of unprofitable business through divestment
(rather than incurring further losses).
4. Consolidation:
A company might have become highly diversified due to unplanned acquisition in the
past. It might sell its unrelated business and consolidate its balanced remaining
business.

Types of Divestment:

1. Sell Off 2. Spin Off

1. Sell Off:
It means selling company‟s part of business to a third party. Usual practice of a large
number of companies to sell off is to divest unprofitable or less profitable business to
avoid further drain on its resources.
2. Spin Off:
When a company creates a new company from the existing single entity it is called
spin off. The spinoff company would usually be created as a subsidiary. Hence, there
is no change in ownership. After the spinoff shareholders hold shares in two different
companies.