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STRATEGIC FINANCIAL

MANAGEMENTModule I


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What is Corporate Restructuring?

Actions taken to expand or contract a firms basicoperations or fundamentally change its asset orfinancial structure.

Activities are broad, range from reorganizing businessunits from product lines to divisions to takeovers or

joint ventures etc.

May involve taking the company private, sellingattractive assets, undertaking a major acquisition, oreven liquidating the company


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Categories

Operational restructuring

Outright or partial sale of companies or product lines

or to downsize by closing unprofitable or non-strategicfacilities.

Also known as divestiture Remove non-core assets

Becoming more focused on core activities

Financial (or debt) restructuring

Actions by the firm to change its total debt and equity

structure, i.e., share repurchase, adding debt or lower

overall cost of capital.


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Corporate Restructuring

It refers to a group of activities that expand or bond a firmsoperations significantly and modify its financial structure or

bring about considerable change in its organizational

structure .

BENEFITS:

Promote efficiency,

Restore growth,

And minimize the cost to tax payers.


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Types of Corporate RestructuringAcquisitions

Mergers

Purchase of a unit or plant

Takeovers

Divestitures- resources of a subsidiary or division are sold to another comp.

- Sell offs

- Demergers: The act of splitting off a part of an existing company tobecome a new company, which operates completely separate from theoriginal company.

- Equity carve outs- sale of partial interest in a subsidiary.

Other Forms of Restructuring

- Going private- Leveraged buyouts: A leverage buyout (LBO) is the acquisition of a

business, typically a mature company, by a financial investor whoseobjective is to exit the investment after 3-7 years realizing an InternalRate of Return (IRR) of in excess of 20% on its investment over thehorizon
http://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/992/company.html


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Merger-Definition

A merger is a combination of two or more companies in

which only one company survives and the merged company

go out of business.

Investopedia explains 'Merger when two companiesbecome one. This decision is usually mutual between both

firms.

In India, mergers, called amalgamations in the legalparlance.


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Mergers may involve Absorption or Consolidation

* In an absorption, one company acquires anothercompany .

Ex.- Hindustan Lever Limited absorbed Tata Oil Mills

Company.

* In a consolidation, two or more companies combine to

form a new company .

Ex.- Hindustan Computers Limited, Hindustan

Instruments Limited, Indian Software Company limited,and Indian Reprographics limited combined to for HCL

Technologies.


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Types of Mergers

Horizontal Mergers

Vertical Mergers

Conglomerate Mergers


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Horizontal Mergers

In a horizontal merger, one firm acquires anotherfirm that produces and sells an identical or similarproduct in the same geographic area and therebyeliminates competition between the two firms.

Ex.-The formation of Brook Bond Lipton India Ltd. through themerger of Lipton India and Brook Bond

The merger of Bank of Mathura with ICICI

The merger of BSES (Bombay Suburban Electric Supply) Ltd. withOrissa Power Supply Company.

The merger of ACC (erstwhile Associated Cement CompaniesLtd.) with Damodar Cement


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Advantages of Horizontal Merger

REDUCTION OF COMPETITION

PUTTING AN END TO PRICE CUTTING

ECONOMIES OF SCALE IN PRODUCTION RESEACH AND DEVELOPMENT

MARKETING AND MANAGEMENT


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Vertical Mergers

Vertical mergers refer to a situation where a product

manufacturer merges with the supplier of inputs or raw

materials.

Vertical mergers may violate the competitive spirit of

markets. It can be used to block competitors from

accessing the raw material source or the distribution

channel.


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EXAMPLES OF VERTICAL MERGER

Time Warner Incorporated, a major cable operation, and the

Turner Corporation, which produces CNN, TBS, and other

programming.

Pixar-Disney Merger


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VERTICAL MERGER-ADVANTAGE

LOWER BUYING COST OF MATERIAL

LOWER DISTRIBUITION COST

ASSURED SUPPLIES AND MARKET COST ADVANTAGE


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Conglomerate Mergers

A conglomerate merger is a type of mergerwhereby the two companies that merge with

each other are involved in different sorts of

businesses.

The importance of the conglomerate mergers

lies in the fact that they help the merging

companies to be better than before.


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Example of Conglomerate Merger

Walt Disney Company and the American

Broadcasting Company.


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Types of Conglomerate Mergers

A. Product Extension Merger:1. It takes place between two business organizations that

deal in products that are related to each other and

operate in the same market.

Benefits: Access to a bigger set of consumers and earns

higher profits.

B. Geographic Market Extension Merger:

* It takes place between two companies that deal in the sameproducts but in separate markets.

Benefits: Access to a bigger market and bigger client base.


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C. Pure Conglomerate Merger: It is one where themerging companies are doing businesses that are

totally unrelated to each other.

Ex- L&T AND VOLTAS


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Company Merged With

A & F HARVEY LTD. MADURA COATS LTD.

A.A.ALLOYS LTD. BHUWALKA STEEL INDUSTRIES LTD.

A.H.BHIWANDIWALA & CO.LTD. GREAT EASTERN SHIPPING CO.LTD.

A.K.STRUCTURAL LTD. SUPREME INDUSTRIES LTD.

A.P.COTEX ASIAN PAINTS LTD.

ABRASIVES & CASTINGS LTD. WOOD POLYMERS LTD.

ACT INDIA LTD. INDRAD AUTO COMPONENTS LTD.

ADDI FASHIONS PVT.LTD. ADDI INDUSTRIES LTD.

ADDI WOOLLENS LTD. ADDI INDUSTRIES LTD.

ADDI WORSTED LTD. ADDI INDUSTRIES LTD.

ADEQUATE WEIGHERS (INDIA)LTD. GILLANDERS ARBUTHNOT & CO.LTD.

ADONI SPG.& WVG.CO.LTD. KOTHARI INDUSRIAL COPN.LTD.

ADVANCE WELDING ALLOYS LTD. ADVANI-OERLIKON LTD.

AEKTA LTD. KIRTIVARDHAN FINVEST SERVICES PVT.

AELPE FINANCE LTD. ORIENT BEVERAGES LTD.

AGIPI CHEMICALS LTD. STANDARD MEDICAL & PHARMA.LTD.

AHMEDABAD LAXMI COTTON MILLS CO.LTD ARVIND MILLS LTD.

AKAR POLYMATIK LTD. AKAR LAMINATORS LTD.

ALCO-CHEM LTD. UPPER GANGES SUGAR & INDUSTRIES LT

ALEMBIC DISTRIBUTORS LTD. ALEMBIC CHEMICALS WORKS CO.LTD.

ALLIANCE FUND MANAGEMENT LTD. ALLIANCE CREDIT & INVESTMENT LTD.

ALU CAPSULES LTD. LARSEN & TOUBRO LTD.

AMBUJA SHIPYARD & SOFTWARE LTD. GALAXY APPLIANCE LTD.

AMIT ALCOHOL & CARBON DIOXDIE LTD. AEGIS CHEMICALS INDUSTRIES LTD.

AMRIT PROTIEN FOOD LTD. AMRIT BANSPATI LTD.

AMRITA EXPORTS PVT.LTD. MADHUR FOOD PRODUCTS LTD.

ANAGRAM FIN.& INDUSTRIES LTD, BROOKE BOND (INDIA) LTD.

ANAGRAM FINANCE LTD. ICICI LTD.


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Acquisitions An acquisition is the purchase of one business or

company by another company or other businessentity.

Acquisitions occur between the bidding and thetarget company.

In the course of acquisitions the bidder maypurchase the share or the assets of the targetcompany.

Acquisition is generally considered negative innature.

An example of this would be the acquisitionofChrysler by Daimler-Benz in 1999.

T 10 i iti d b I di i
http://en.wikipedia.org/wiki/Chryslerhttp://en.wikipedia.org/wiki/Daimler-Benzhttp://en.wikipedia.org/wiki/Daimler-Benzhttp://en.wikipedia.org/wiki/Daimler-Benzhttp://en.wikipedia.org/wiki/Daimler-Benzhttp://en.wikipedia.org/wiki/Chrysler


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Top 10 acquisitions made by Indian companies

worldwide:Acquirer Target Company Country targeted Deal value ($ ml) Industry

Tata Steel Corus Group plc UK 12,000 Steel

Hindalco Novelis Canada 5,982 Steel

VideoconDaewoo

Electronics Corp.

Korea 729 Electronics

Dr. Reddys Labs Betapharm Germany 597 Pharmaceutical

Suzlon Energy Hansen Group Belgium 565 Energy

HPCLKenya Petroleum

Refinery Ltd.Kenya 500 Oil and Gas

Ranbaxy Labs Terapia SA Romania 324 Pharmaceutical

Tata Steel Natsteel Singapore 293 Steel

Videocon Thomson SA France 290 Electronics

VSNL Teleglobe Canada 239 Telecom


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Other forms of Restructuring

Demergers: The act of splitting off a part of an

existing company to become a new company,which operates completely separate from the

original company.

Divestitures: It refers to the sale by a company ofa product line or a subsidiary or a division.

In other words, Selling of a segment of a

company to a third party which is an outsider forcash or for
http://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/992/company.html


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Spin Off

It is a kind of a demerger where an existing parent company

distributes on a pro-rata basis all the shares to its controlledsubsidiary or its own shareholders by which it gains effect to

make two of the one company or corporation.

There is no money transaction, subsidiarys assets are not

valued. Both the companies exist and carry on business. Itdoes not alter ownership proportion in any company.

Split Off:

This occurs when equity shares of a subsidiary company are

distributed to some of the parent companys shareholders

in exchange for their holdings in parent company.


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Business Alliances. A business alliance is an agreementbetween businesses, usually motivated by cost

reduction and improved service for the customer. An example Alliance of Apple, Motorola and IBM,

intended to tackle Intel's microprocessor monopoly,

Franchise: Franchising is the practice of using anotherfirm's successful business model.

Coca-Cola, gasoline companies, fast food franchisorssuch as McDonalds, KFC, Pizza Hut and Subway

franchise systems have pioneered the franchiseconcept in India.
http://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Business_model


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Joint Venture: This is an agreement between two or morecompanies where there will be an agreed contribution andparticipation of the respective companies.

Sony-Ericsson is a joint venture by the Japanese consumerelectronics company Sony Corporation and the Swedishtelecommunications company Ericsson to make mobile phones.The stated reason for this venture is to combine Sony'sconsumer electronics expertise with Ericsson's technological

leadership in the communications sector. Both companies havestopped making their own mobile phones.

Virgin Mobile India Limited is a cellular telephone serviceprovider company which is a joint venture between Tata Tele

service and Richard Branson's Service Group. Currently, thecompany uses Tata's CDMA network to offer its services underthe brand name Virgin Mobile, and it has also started GSMservices in some states.


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Equity Carved Out : It is a type of divestiture

where a sale of partial interest in a subsidiary. Some of the subsidiarys shares are offered for

sale to general public for increasing cash

inflow without losing control. This is also called split off IPO.


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Going Private:it refers to the transformation of apublic corporation into a privately hold firm.

It involves purchase of the entire equity interest in apreviously public corporation by a small group of

investors.

Leveraged Buy outs: A leverage buyout (LBO) isthe acquisition of a business, typically a mature

company, by a financial investor whose objective is

to exit the investment after 3-7 years realizing anInternal Rate of Return (IRR) of in excess of 20% on

its investment over the horizon


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Takeovers

A corporate action where an acquiring company

makes a bid for an acquiree. If the target company is

publicly traded, the acquiring company will make an

offer for the outstanding shares.


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Takeover might be :

Hostile Takeover

A takeover attempt that is

strongly resisted by the

target firm

Friendly Takeover

Target company's

management and board of

directors agree to a merger or

acquisition by another

company.


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WHY SHOULD FIRMS TAKEOVER?

To gain opportunities of market growth more quicklythan through internal means

To seek to gain benefits from economies of scale

To seek to gain a more dominant position in a national

or global market To acquire the skills or strengths of another firm to

complement the existing business

To acquire a speedy access to revenue streams that it

would be difficult to build through normal internalgrowth

To diversify its product or service range to protect itselfagainst downturns in its core markets


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Reasons for Mergers

To limit competition.

To utilize under-utilized market power. To overcome the problem of slow growth and profitability in one industry.

To achieve diversification.

Staff reductions.

Economies of Scale.

Displacing existing management. Acquiring new technology-To stay competitive, companies need to stay

on top of technological developments and their business applications. Bybuying a smaller company with unique technologies, a large companycan maintain or develop a competitive edge.

Improved market reach and industry visibility-Companies buy companies

to reach new markets and grow revenues and earnings. A merge mayexpand two companies' marketing and distribution, giving them new salesopportunities. A merger can also improve a company's standing in theinvestment community: bigger firms often have an easier time raisingcapital than smaller ones.


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Value Created by Merger

A merger must provide economic advantage

to acquiring firm.

For ex.- firm P & Q merge and they are

separately worth Vp and Vq respectively and

worth Vpq in combination, then economic

advantage of merger will occur if;

Vpq>(Vp+Vq)


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Case Study Firm P has a total market value of Rs. 18 crores (12 lakh

shares of Rs. 150 market value per share). Firm Q has atotal market value of Rs. 3 crores (5 lakh of Rs.60 market

value per share).firm P is considering the acquisition of

Firm Q. The value of P after merger is expected to be Rs.

250 crores due to efficiencies. Firm P is required to pay

Rs. 4.5 crores to acquire Firm Q.


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Solution

Net Economic Advantage:=[Vpq-Vp-Vq]-[Cash Paid-Vq]

Vpq = value of combining firm

Vp = value of firm PVq = value of firm QThe net economic advantage of Merger=[ 25-(18+3)]-[4.5-

3]=2.5 crores


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Exchange Ratio

The number of shares of the acquiring companythat a shareholder will receive for one share of

the acquired company.

The exchange ratio can be calculated as follows:On the basis of Market price of shares.

on the basis of EPS.

On the basis of book value of shares


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CASE STUDY

XYZ Ltd. is considering merger with ABC Ltd. XYZ Ltd. shares arecurrently traded at Rs. 25. It has 2 lakh shares outstanding and its

earning after taxes (EAT) amount to Rs.4 lakh. ABC Ltd. has 1 lakhshares outstanding; its current market price is Rs. 12.50 and its EATis Rs. 1 lakh. The merger will be affected by means of stock swap(exchange). ABC Ltd. has agreed to a plan under which XYZ Ltd. willoffer the current market value of ABC Ltd. share.

1. what are the pre merger earnings per shares (EPS ) & P/E ratiosof both the companies?

2. if ABC Ltd. P/E ratio is 8 what is its current market price? What isthe exchange ratio? What will XYZs Ltd. post merger EPS be?

3. what must the exchange ratio be for XYZ Ltd. pre merger andpost merger EPS to be the same?


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XYZ ABC

Market price of shares Rs. 25 Rs. 12.50

No. of shares outstanding 2,00,000 1,00,000

Earning after tax Rs. 4,00,000 Rs. 1,00,000

1)EPS Rs.2.00 Rs.1.00

P/E Ratio= Market price per share

Earnings per share

Rs. 12.50 Rs. 12.50

2) If ABC Ltd. P/E ratio is 8, its current market price will be 8x Rs. 1= Rs. 8. Then theexchange ratio will be 8/25 i.e., 32/100. For every 100 shares of ABC, 32 shares of XYZ

will be issued (100000x32/100)32000 to its shareholders.

Post merger EPS of XYZ Ltd.= Total Earnings/ Total Shares= Rs. 5,00,000/2,32,000 shares

= Rs. 2.16 per share.

3) After Merger EPS= Rs. 2, Total Earnings Rs.5,00,000

Hence, Rs.5,00,000, Rs.2= 2,50,000 shares i.e., 50,000 shares of XYZ will have to be issuedto the shareholders of ABC i.e., one share of XYZ will be issued for every two shares held

by ABC Shareholders.

Solution


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DCF Evaluation of Mergers

CASE STUDY ON DEMERGER


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CASE STUDY ON DEMERGER

Reliance Industries Limited

- A Unique Scheme of Arrangement-

FACTS

PREARRANGEMENT SCENARIO

Reliance Industries Limited was

engaged in various businesses:

(i) Coal based power business;

(ii) Gas based power business;

(iii) Financial services business;

(iv) Tele-Communication business


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The family arrangement aims atSegregation between the two Ambani Brothers

Provision for Specified Investors was made:

Holdings of RIL and other companies in the control of Mr.Mukesh Ambani were transferred to a wholly owned

subsidiary, Reliance Industrial Investments and Holdings

Limited (RIIHL) along with a Private Trust (Petroleum

Trust).

RIIHL and Petroleum Trust were described as Specified

Investors which renounced their rights in the scheme

itself.

RIL demerger

RIL demerger


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As a result of demerger the shareholders of Reliance Industries

Ltd. other than SpecifiedInvestors got one share each in thefollowing four resulting companies for each share held in RIL as

on the record date:

Reliance Energy Venture Ltd. (REVL)

Reliance Communication Venture Ltd. (RCOVL)

Reliance Capital Venture Ltd. (RCVL)

Reliance Natural Resources Limited (RNRL)

The shares of all these resulting companies got listed on the

stock exchanges under the provisions of Cl 8.5.3.1 of the SEBI

(DIP) Guidelines.

RIL demerger

Benefits achieved


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Benefits achieved..

Particulars Amount

(Rs.)24th March 2006

Amount

(Rs.)20th December,

2007

Value of the shares heldby a shareholder as onrecord date (25th

Jan,2006) (A)

100 shares @928

92800

Shares in RIL 100 (@708) 70800 (@2700) 270000

Shares in REL 100 (@38) 3800 (@1900) 90000

Shares in RCOL 100 (@290) 29000 (@706) 70600

Shares in RCL 100 (@24) 2400 (@2376) 237600

Shares in RNRL 100 (@23) 2300 (@163) 16300

Total 108300 684500

Net benefit 15500 576200


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Legal and Procedural aspect of Merger

Indian competition law grants a maximum time period of 210 days for the determination of thecombination, which comprises acquisitions, mergers, amalgamations and the like. One needs to

take note of the fact that this stated time frame is clearly distinct from the minimum compulsorywait period for applicants.

As per the law, the compulsory period of waiting for applicants can either be 210 days startingfrom the day of notice filing or receipt of the Commission's order, whichever occurs earlier.

The threshold limits for firms entering business combinations are substantially high under the

Indian law. The threshold limits are set either in terms of the asset value or or in terms the firm'sturnover. Indian threshold limits are greater than those for the EU. They are twice as high whencompared with UK.

The Indian law also provides for the modern day phenomenon of merger and acquisitions, whichare cross border in nature. As per the law domestic nexus is a pre-requisite for notification on thistype of combinations.

It can be noted that Competition Act, 2002 has undergone a recent amendment. This has replacedthe voluntary notification regime with a mandatory regime. Of the total number of 106 countries,which possess competition laws only 9 are thought to be credited with a voluntary notificationregime. Voluntary notification regimes are generally associated with business uncertainties.

Post-combination, if firms are seen to be involved in anti-competitive practices de-merger showsthe way out.


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Tax Implication of Merger and Acquisition Indian Income Tax Act has provision for tax concessions for mergers/demergers

between two Indian companies. These mergers/demergers need to satisfy theconditions pertaining to section 2(19AA) and section 2(1B) of the Indian

Income Tax Act as per the applicable situation.

In case of an Indian merger when transfer of shares occur for a company theyare entitled to a specific exemption from the capital gains tax under theIndian I-T tax Act. These companies can either be of Indian origin or foreignones.

A different set of rules is however applicable for the 'foreign companymergers'. It is a situation where an Indian company owns the new companyformed out of the merger of two foreign companies.

It can be noted that for foreign company mergers the share allotment in themerged foreign company in place of shares surrendered by the amalgamating

foreign company would be termed as a transfer, which would be taxable underthe Indian tax law.

Also as per conditions set under section 5(1), the 'Indian I-T Act' states that,global income accruing to an Indian company would also be included underthe head of 'scope of income' for the Indian company.


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International Mergers and Acquisitions

These mergers and acquisitions refer to those mergers and acquisitions thatare taking place beyond the boundaries of a particular country. International

mergers and acquisitions are also termed as global mergers and acquisitions orcross-border mergers and acquisitions.

International mergers and acquisitions are taking place in different forms, forexample horizontal mergers, vertical mergers, conglomerate mergers,congeneric mergers, reverse mergers, dilutive mergers, accretive mergers andothers.

International mergers and acquisitions are performed for the purpose ofobtaining some strategic benefits in the markets of a particular country. Withthe help of international mergers and acquisitions, multinational corporationscan enjoy a number of advantages, which include economies of scale andmarket dominance.

International mergers and acquisitions play an important role behind thegrowth of a company. These deals or transactions help a large number ofcompanies penetrate into new markets fast and attain economies of scale.They also stimulate foreign direct investment or FDI.

M th d f Fi i I t ti l M d


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Methods of Financing International Mergers and

Acquisitions

Financing (or taking loans)

Cash

Factoring

Hybrid Financing


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Following are the instances of the major international mergers

and acquisitions:

The merger of British Petroleum (BP) with Amoco (erstwhileStandard Oil of Indiana)

The acquisition of Mannesmann AG by Vodafone Airtouch PLC

The merger of Exxon with Mobil (The name of the companyformed as a result of the merger is ExxonMobil)

The acquisition of AirTouch Communications by the VodafoneGroup

The acquisition of Compaq by Hewlett-Packard

The acquisition of Shell Transport & Trading Company by

Royal Dutch Petroleum Company The merger of Bank One Corporation with JPMorgan Chase &

Company


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Factors Affecting International Mergers and

Acquisitions

Corporate governance

Company acts

The capacity of average workers

Expectation of the consumers

Political features of a country

Tradition and culture of a country

Documents

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