Chapter III-Merger & Acquisition

8/2/2019 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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Documents

Chapter III-Merger & Acquisition