Text

International College of Economics and Finance

Academic research paper

State ownership and the M&A deal structure

MSc 1st year student

Daria Volkova

Argument Consultant

PhD Keyong Hun Lee

Moscow, 2015

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Contents

# of page

Abstract 3

Part 1. Introduction 4

Part 2. Discussion 6

Section 2.1 Overview of M&A market in Russia 10

Section 2.2Literature review 22

Section 2.3Methodology 23

Part 3. Conclusion 24

Bibliography 26

Additional materials

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Abstract

This paper is an extended proposal of future research, which seeks to contribute to the

existing literature in the field of state ownership and the M&A deal structure. In the focus of

investigation one might find the Russian M&A market, which has a large share of the deals with

state-controlled companies involved. The influence of the government on the deal structure is

observed in two acpects. First one is the choice of the method of payment by the acquirer which

might be affected by the presence of political connections (low-cost loans, etc.). The second one

is a market performance of acquirer after the deal announced which might be relatively better

due to the presence of state control on board. These questions are widely theoretically described,

and the methodology of future research is provided.

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Part 1. Introduction

Mergers and acquisitions constantly take place worldwide. The companies have many

incentives to contemplate such transactions. One can name the synergy effect, which improves

the companys position in the sense of the economy of scale, gain in efficiency and improved

market visibility. In some cases the involed parties are looking for the gain in new technologies

or goodwill-like assets which come around during the time. In fact, true mergers are rarely

happened. In many cases talking about M&A one assumes the acquisition, even if the merger

took place. Quite often such thing happens because of the public perceptions and staffs

considerations, meaning that its better for them to accept the idea of a merger than a news about

an acquisition.

When the M&A transaction takes place, therere several issues that should be addressed

up to to the beginning of the procedure. One could sum it up to the 10 most important aspects of

the deal/16./. It includes such seriuos questions as the deal structure, cash versus equity issues,

the problem of working capital adjustment, earnout as a pricing structure, compensation for a

target, liabilities issue and the problem of non-solicitation. One can provide more details on the

deal structure question. Therere 3 main options applicable for the M&A transactions

structuring: stock purchasing, sale of the assets and the merger itself. The type of the structure

depends on the negitiation position and competing interests of both the acquirer and the target.

The chosen type leads to several consequences, which normally are taking into account till the

begging of the transactions. These concequences are the following: transferability of liability,

consents of the third party, shareholders approval and the taxation issues.

The second point which should be carefully addressed as one of the most important parts

of the M&A deal is the method of payment. Some companies choose to pay in cash, while others

prefer to pay in stock. From the targets point of view, cash is known as a mostly riskless and

quite liquid source of the deals financing. The value of the deal is sustained to be constant in the

sense that it doesnt vary with the value of the stock. From the acquirers point of view, payment

in cash can be easily conducted with the exessive funds from either working capital or the

unlimited credit line. However, these source of financing may lead to the impairement of the

credit ratios. On contrary, such mode of payment as an equity may enhance the credit rating of

the acquirer, which is inevitably good for the company. One may notice that issuing stock to the

holders of the target leads to the dilution, which may be unwilled by the shareholders of the

acquiring company, especially if its partially or entirely state-controlled.

One would reasonably extand the idea of state controlled enterprises and its participation

in the M&A process. This topic is extremely vital topic for the emerging economies. Most of

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these countries had an experience of so-called privatization, which means the process of

transferring the ownership from the government to the private sector. However, in many

countries this process has not been completely finished: large part of the companies, which

operate as a solo entities,are partially or entirely owned by the state. While the previous research

was mostly concentrated on the other aspects of M&A market, one would rise a question of the

state-controlled companies as a participants of the M&A transactions. One would ask several

questions concerning the role of state-controlled companies in the M&A field:

What is the scale of participation in M&A deals by the state-controlled

companies?

What are the details of the M&A deals, in which the state-controlled companies

are involved?

Is there an evidence of the backward ownership transferring in the sence that

M&A deals lead to the state control expansion throug the corporate sector?

These questions will be addressed in the paper, using the quantitative and qualitatile approached

with respect to the Russian market of M&A deals. The rest of the paper would be organized as

follows. In the discussion part one would start section 1with a review of M&A market in Russia.

In the section 2 one would describe the previous research in three major directions related to the

topic:

the impact of state ownership on the M&A market in Russia;

the impact of state ownership in the context of the availability of financial resources on

the method of payment along with another substaintial theories;

theimpact of state ownership on the acquirers performance: the direct one and the

indirect one (via the method of payment).

In section 3 one would provide the methodology of own research. Then it follows the concluding

commets and remarks.

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Part 2. Discussion

Section 2.1. Overview of M&A market in Russia

Before one can jump to the overview of previous research conducted in field of M&A

deal structure and the state ownership aspect, it needs to make a brief description of the current

market situation and give some hystorical statistics on the M&A in Russia. After a short

analytical note the rest of this part will be logically divided into 3 sections, each of them is

devoted to the literature review, methodology and the prospects of future research respectively.

First of all, one would be precise about the meaning of state-controlled companies. Its

convenient to assume that this kind of companies have the state as a shareholder with 50% or

more percents of voting shares. It can also be the case when more than 50% of voting shares

belong to both the state and 100% state-owned companies. The last case which one can assume

is the subsidary of the state-owned company. This diversification will be important further.

Additionally, one would treat the companies as state-participated if theres even a minority

interest of the state in the equity.This would be necessary when studying the method of payments

as an element of M&A deal structure. Moreover, one would rationally drop off the non-

commercial state-owned companies which are functioning as an instrument of government

policy, fore example, Rosnano, Rosatom, etc. Russia is chosen as a sampling base due to the fact

that its economy can be reffered as an emerging. It has also went through the privatization period

which makes it highly representative.

The short statistics of M&A activity in Russia would be very useful in the light of futher

research /8./. Current information contains the particular data from 1997 up to nowadays. During

this period, one would point out several highlighted moments. During the period between 1997

and 2002 the averagetotal deals value per year was approximately US$5 bln, which can be

treated as a very slack period for the Russian M&A market.In 2003 there was a beginning of the

actual M&A activity in Russia with total deals value of US$18,5 bln (270% increase). This year

was marked with the largest merger (US$6,4 bln) of Tyumen oil company with British

Petroliumwhich resulted as joint company TNK-BP. Next years till 2007 the M&A market

continued to grow. Particularly, in 2005 the first mega deal the acquisition of Sibneft by

Gazprom1for US$13,1 bln was completed, which led to the two times increase in the average

total value of deals (US$40,5 bln). However, in 2008 there was a huge slowdown in M&A

activity due to the global financial crisis, inevitably influenced Russian economy. Same trend

was hold till 2012, when the second mega deal (US$56 bln) the acquisiotion of TNK-BP by

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Gazprom has finished the acquition of Sibneft. URL: http://quote.rbc.ru/news/merge/2005/10/21/5206887.html

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Rosneft2 was completed. This deal came out the second largest deal in the world in 2012. Since

2013 up to 2015 there was a downward trend in M&A activity in Russia. The plot 1 provides the

details of M&A activity in Russia, including the data on the number of deals and its total value

per year.

Plot 1. Source: [8]

According to the latest statistics, in 2014 one can indicate the significant increase in the

total number of deals, which is 595 deals, while in 2013 there were only 316 deals. However, as

it was mentioned above, theres a decline in the total value of deals (US$71 bln in 2014 versus

US$115 bilion in 2013). The lack of liquidity due to financial situation led to the decrease of the

number of very large deals. Here one considers the deal as a very large if its value is more than

US$2 bln. Based on the analysis of the whole period of M&A activity in Russia, one might

notice that normally only very large deals stimulated the M&A market to grow. Basically, in

2014 there were only 3 announcements about the very large deals, while in 2013 there were a

way more (14 announced deals). On the other hand, the one can indicate the significant increase

in total number of relatively small deals, which account for the deals with the value of US$100

million or less. Thus, in 2014 there were 293 relatively small deals, which is almost three times

2 The deal of the century: Rosneft acquires TNK-BP. URL: http://smart-lab.ru/blog/83473.php

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M&A dynamics in Russia (2005-2014)

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total number of deals

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more than in the previous year (103 deals).

To biuld the forecast on 2015, one would take into account the hystorical data on the

M&A activity in Russia. The comparison of 2009 and 2007 shows that the decline in post-crisis

period was almost 70%. Reasonably, one can assume that the decline in 2015 would be very

similar to this number. The decline of the M&A activity in 2014 was almost 50% comparing

with plentiful year 2012. Consequently, 2015 year would have the decrease in almost US$30 bln

of total value of deals. However, one should consider the common dynamics of the Russian

economy after the crises both in 2008 and nowadays. The data on the GDP growth demostrates

approximately 8% decline in 2009 after crisis year 2008, while nowadays one can forecast twice

less decline in the GDP growth. Thus, the decline in the M&A activity might be less crutial that

after the financial crisis in 2008.

The global M&A marketdemonstrates the positive trend to grow (plot 2). According to

the data, the total value of deals in 2014 grew up on 44,5%, reaching the value of US$3,26

trillion, which is quite lower than the total value of deals in 2007, preliminary year of financial

crisis. In this situation one may notice than emerging markets stand for the center of M&A

activity in the world. Using the emerging markets abbreviation one assumes such regions as

China, India, Middle East [Egypt, Morocco, Turkey, Saudi Arabia, UAE], Russia, Brazil.

Basically, the BRIC countries are the leaders in the number of M&A deals, absorbing up to 60%

of all transactions in the world. The buyers are attracted by a fast growing consumer sector in

this economic block. Moreover, accoding to the statistics, each 4th

M&A deal involves a

company listed in BRIC region as a buyer or seller.

One would analyse why the BRICs companies do participate in M&A deals. Therere basically

3 main reasons. First of all, BRICs companies are looking for an access to the energy and

natural resources in order to stimulate the economic development of their own country.

Secondly, these companies try to meet the increasing demand on the consumer goods for the

middle class. Thirdly, the participation in M&A deals is a good way to obtain the modern

technologies and most up-to-date management techniques. Buying the assets in mature

econonies, the buyers from BRIC countries try to find such assets which may become a platform

for the global expansion of their business. One may also note that the companies from BRIC

block are more interested in modern business techniques rather than in new technologies. The

main point of acquiring the companies from mature economies is the transferring of business

experience and the access to the new markets.

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Plot 2. Source: [8]

The latest research of BCGdemonstrates that the buyers from mature economies which

develop M&A deals on emerging markets get lower profit that the buyers from emerging

markets doing the same at home. It can be explained by the fact that investors from emerging

economies are well-acquainted with the culture of a target, including the language, corporate

culture and motivation of a target. Due to this advantage the average abnornal returns to the

stock of acquirer from the mature economies are two times lower (1,1%) than the same indicator

for the buyers from emerging markets(2.05%). However, its not always true, especially if the

acquirer from the mature economy has a substaintial experience in development of M&A deals

on emerging markets (6 or more deals completed). In this case the average abnormal return

raises up to the given level of 2%.

Back to the case with Russian economy, one say cross-border M&A in Russia

significantly increased after the WTO accession due to the bureaucratic barriers easing. The

natural resources are no longer the most popular direction of M&A activity. It moved out by the

consumer companies from mature economies which are acquiring plenty of Russian companies.

However, this trend might be neglected in the future because of the Ukrainian crisis. One might

notice that most actively developing direction of M&A in Russia tends to be the domestic deals.

During several year the share of domestic deals constantly varies in 70-80% out of all deals

completed. Despite the fact that there was a positive statistics in 2014, the business environment

tends to decade due to the tight economic and political situatoin. The companies did slowdown

in the overall M&A process the own growth rates. Such cofactors as a drop in oil prices and

2428 3295 3670 2409 1711 2089 2249 2295 2259 3259

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M&A dynamics in the world (2005-2014)

total value of deals (US$ bln) total number of deals

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depeciation of ruble defined the terrifical decrease in M&A activity till US$6,6 bln in the 4th

quarter of the year (the minimal total value of deals through 5 years).

One might analyse the structure of domestic M&A activity in Russia and highlight the

most active sectors of the economy which were involved in the M&A activity. The most

dynamic one was the real estate and reconstruction (153 versus 63 deals). The total share of this

sector in the overall number of deals was 25%. The state-controlled companies had a significant

impact on the dynamics in this sector: they have participated in 43% of all deals completed in the

real estate and reconstruction sector. Such dynamics can be explained by the fact that inverstors

appreciate the real estate as a sustainable asset which will not depreciate in time, especially if the

state-controlled companies sell out their assets. One more reason of such popularity of this sector

is the fact that infrustructure development attracts the financial support from the state. Not

surprisingly, there was a quite huge deal of acquiring the 43,9% of Stroygazconsulting

(construction holding) by the private investor Ruslan Baysarov [9]. One would treat it as

acquisition because actually the strategic investor acquires the the part of the company.

However, therere several other sectors where M&A activity presented. Its consumer sector,

banking and insurance, telecommunications, media and innovations. Moreover, one would treat

the situation around all the sectors as not very stable, meaning that some of them performed to

the less extent that the others. Thus, theres a huge fall in M&A activity in metals and mining

sector (decreasein 68,9% compared with 2013 year). The more details on the largest deals in

2014 are collected in the table 1 in the Additional materials section.

Later on the cross-border M&A activity in and out of Russia should be analysed. With

escalating the Ukrainian conflict, the total volume of outboard investments decreased

significantly (aprroximately 50% less then in the previous year, reaching the value of USUS$8,1

bln). Its the greatest shortcut since 2009, which was basically the post-crisis year. The buyers

from Europe and USA competed more than 2/3 of all cross-board deals with of total value of

all cross-border deals. Surprisingly, the buyers from the countries of Asia Pacific region

demonstrated a very little interest in completing the deals through the period of 2010-2014. The

share of such deals during given period was only 8,1% out of total selling assets to foreign

acquirers. Even more astonishing results are provided by 2014 year, when the share of such deals

reduced in 97%. The Chinese companies were assumed to be mostly interested in the buying of

the assets of Russian companies. However, there were only 2 deals completed in 2014 between

Chinese and Russian companies with non-disclosed value of the deal. One can assume that one

of the reasons of low transaction activity between China and Russia can be the fact that Chinese

companies are very strong in their negotiation position. Thats why the expectations of both

parties do not concide quite often.

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The activity of Russian companies outside of the country is also very intersting point.

As it was mentioned above, in 2014 the Russian economy has a shock of depreciation of

domestic currency. One would forecast the negative effect of this event on the willingness of

Russian companies to participate in acquisition of foreign companies. However, the tendency

was the opposite. The total value of deals in buying foreign assets by Russian companies

increased on almost 50% (USUS$7,1 bln) with an equivalent increase in the total number of

deals (80 deals in 2014 versus 40 deals in 2013). Russian companies mostly targeted European

and Former USSR countries - 65% out of total value of deals where Russian companies bought

some assets from abroad and almost same share these deals took out of the total number of deals.

The largest deal in this import M&A activity was the acquisition of gold producer Altynamas

Gold by Polymetal with the deal value of USUS$1,08 bln. The nice tendency of import M&A

activity is the shift from buying the energy and natural resoursed companies only to the

companies out of wider range of sectors. Namely, in 2013 almost 80% of total value of all

import M&A deals were related to the energy and natural resources sector, while in 2014 it was

only 25%. Comparing the number of deals, in 2013 there was each four out of five deals related

to the energy and natural resources sector, while in 2014 each 1st out of 5 deals were related to

this sector. The diagram shows that some sectors perforemed incredibly high in 2014 such as

banking and insurance, consumer products, innovations, real estate and reconstruction.

Since a wide review of Russian M&A market leaves an open question about the state-

controlled companies, one would analyse its performance in detail. The next section is devoted

to the review of previous research in this field and some particular studies concerning the state-

controlled companies in Russia.

Section2.2. Literature review

Addressing the question on the impact of state ownership on the M&A market in Russia One would start with a paper of Russian economist Alexey Lyakin(2010) /9./. This paper

mostly addresses to the problem of privatization in Russia. The author points out that the size of

the private and government sector in Russia constantly changes. One of the channels of these

changes is mergers and acquisiotions, where both corporate and state-controlled companies

participate. This process began after 1990th

, when huge reforms in the Russian economy were

done. The author is particularly interested in the scale and dynamics of this process of changing

the size of corporare sector by the means of M&A.

This paper provides very interesting data on the M&A activity of state-controlled

companies during the period 2003-2009 yrs. The tabel 2 presents the data on the total value of

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the deals for a given period. The estimates of this indicator are quite different from the ones

given by KPMG due to methodological issues. However, the levels approximately coincide. So,

from this tabel one may conclude that the state-controlled companies are more ofter the acquirers

than the targets. This is true with any total value of the deals with state-controlled companies

involved. This indicator varies quite well, from 18,3 up to 57,8% in some years. One might see

that within the mechanism of M&A the state-controlled ownership significantly expands. One

more interesting point in this table is the following: the overall surplus of assets bought from

corporate sector to the assest sold noticeably varies with the minimum value in 2003 (US$33

mln) and the maximum value in 2007 (US$20,2 bln). There was also extremely large surplus in

post-crisis 2009 (US$16,1 bln).

The structure of M&A deals with state-controlled companies involved (2003-2009)

# Values 2003 2004 2005 2006 2007 2008 2009 sum

1 Total value of all deals completed (US$ bln) 8,8 22,9 33 39 121 73 54,7 352,4

2

Total value of deals with state-controlled companies (US$ bln) 1,6 12,4 15,4 6,1 70 19,2 18,6 143,3

Share out of [1] 18% 54% 47% 16% 58% 26% 34% 41%

Using [2], total value of the deals:

3 between state-controlled companies (US$mln) 825 1762 20 569 15921 3808 1120 24025

Share out of [1] 9% 8% 0% 1% 13% 5% 2% 7%

4

selling from state-controlled to purely private companies (US$mln) 377 984 971 1030 16779 6201 655 26997

Share out of [1] 4% 4% 3% 3% 14% 8% 1% 8%

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selling from purely private companies to state-controlled (US$bln) 0,41 9,7 14,4 4,5 37 9,2 16,8 92,01

Share out of [1] 5% 42% 44% 12% 31% 13% 31% 26%

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Table 2. Source: [9]

One might also note the peculiar dynamics of this process. The most active buy-side

M&A activity of state-controlled companies was hold in 2004-2005 and 2007 yrs. Once again

one might take into account that when the state-controlled company acquires some pure

corporate company, basically the state transfers back the ownership. Its like backward

privatization // nationalisation. The given period is directly linked to the expansion of state-

controlled corporations in the oil/gas sector. However, in 2008-2009 one might notice the

significant change in the way of M&A activity of state-controlled corporations. During this

period most deals were completed between the large state-controlled banks and the industrial

producers. Basically, the state-controlled banks used the budget funds to acquire purely private

companies, while the targets used the payment for their assets to repay the debts. The common

observer could treat it as a realisation of anti-crisis program stated by the government. As an

example of such deals one might consider the acquisition of Angstrem Group the producer of

intergated circuits by the state-controlled Vnesheconombank for US$1,2 bln. With the similar

scheme the 30% of stock of Rostelecom - national telecommunications operator was

transferred under state control3. Same happened with the IzhAvto, the national automobile

producer, due to the bankruptcy4.

Share of mega deals with state-controlled companies involved on Russian M&A market

# Values 2004 2005 2006 2007 2008 2009

1 Total share of mega deals with SC companies involved 89% 84% 59% 64% 44% 88%

Out of [1], the sectors involved

Oil & Gas 89% 84% 59% 43% 5% 13%

Financial sector - - - - 28% -

Energy & Natural resources - - - 21% 11% 17%

Telecommunications - - - - - 39%

Real estate & Reconstruction - - - - - 13%

Information technologies - - - - - 6%

3 http://top.rbc.ru/finances/10/06/2010/419402.shtml 4 http://top.rbc.ru/economics/23/11/2011/626416.shtml

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Table 3. Source: [9]

However, the author says that the scale of nationalization through M&A didnt reach the

same extent as it was demostrated by the European countries. During the crisis period the

activity of Russian state-controlled companies in M&A process was significantly slack. Most of

the deals completed during the crisis period were supposed to cover national interests in

prevailing in several key industries (financial sector, oil and gas, telecommunications). The other

part of the deals was completed due to the natural reasons, such as the probability of bankruptcy,

etc. In other words, the companies sold out their assets in order to repay the growing debts,

which is quite natural for the period of recession. One may conclude that the share of state-

controlled companies extended through M&A process during the good times in the market and

shortened in the bad times. As it was said above, the deals in 2009 were completed due to

financial problems of the companies or the pursueing of states interests in technological

problems solving. As an examples of the second point, one might use the acquisition of drilling

companies by the state-controlled oil producer Transneft or the acquiring of ferry businesses by

the state-controlled Russian Railways RZD.

The industrial structure of the acquisition by the state-controlled companies is very

interesting. From this table 3 one might follow the main interests of the state in the limited

number of industries. The state-controlled companies were not involved in any mega deals

during given period. The only exception is oil and gas industry, where several mega deals were

completed in the period 2004-2006. One of the possible explainations can be the fact that

according to the Russian law any mega deal should be confirmed by the board of directors and

common shareholders meeting. Consequently, these kind of deals should be also verified by the

special government parties (ministries, etc.) with a written announcements from the company

about the voters decision taken by the directors and shareholders.

The very last point mentioned by the author of this paper was the comparision of M&A

activity in Russia with and without state-controlled companies patricipation. According to the

authors estimation, oil and gas sector takes the leadership in M&A activity in Russia, even

without state-controlled companies participation. However, the financinal sector has almost the

same share of the total value of deals in the section of pure private companies through the period

as it has metals sector with the leadership to the last. Therere quite few companies in metals

sector which are state-controlled, meaning that most of the companies in this sector are pure

corporate. However, these sector most actively participates in M&A in Russia.

Addressing the question of the impact of state ownership in the context of the

availability of financial resources on the method of payment along with another

substaintial theories

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Therere many theories which attempt to explain the difference in financing the deals.

One would try to cover some of them which are mostly relevant to the problem of state

ownership and M&A deal structure. First, its necessary to address the question of the deal

structure. Therere many aspects which belong to this concepts but here and longer we would be

searching into the area of M&A deal financing. As it was covered in the introduction, therere

two ways of deal financing: either cash or equity payment. If the company has correctly chosen

the mode of payment, it has at least three advantages: lower costs on capital, increased

diversification of risks and the increase in the well-being of the shareholders from the acquirers

side. Although the research in the field of state ownership and the deal structure leads to some

theoretical insides like the deep understanding of the state policy functioning through the M&A

process, one would also note that the studying of this topic gives food for thought to the

management of the company. It gives the opportunity to choose more correctly the way of

financing the deals, because the consequences of each of the cases are widely examined.

One would take into consideration the fact that the emerging markets are obviously

functioning in a different way, rather than the mature economies. It has such particularities as the

deep information asymmetry and relatively weakly developed markets of debt and equity. Its

true also for the Russian M&A market. As it was noted earlier, most of the emerging economies

have the great share of state-controlled companies. One may conclude that in these

circumstances the deal struture would be different from the one studied in the most of the

previous papers because the management can probably have another motives which should be

considered addressing the question of M&A deal financing.

Since we already widely covered the state ownership issue on the Russian M&A market,

one would like to address the question of the deal financing more detailed. It would be short-

sighted to assume that only state ownership determines the mwthod of payment chosen by

acquirer. Thus, on may note the necessity to observe the main theories which which attempt to

explain the different M&A financing are developing during the last 20 years. Most of these

papers are examing the mature economies, since historically it has the largest share of M&A

delas completed in value and the number of deals, as well as the information available for the

research. In the following parts one would describe the most relevant theories which were

developed to explain the difference in the method of payment.

The information asymmetry

This theory intitially was introduced by Stewart Mayers and Nicholas Majluf /11./. The authors

use the microfoundationed approach to address the question of the method of payment.

Basically, the authors assume that the acquirer and the other parties may have the different

16

information about the actual perspectives of the acquirer. Its an example of information

asymmetry in practice. Thus, if the acquirer perceives its stock as undervalued, it would

probably tend to use cash as a method of payment. On contrary, if for some reason the acquirer

values its stock higher than the market, it would use equity to finance the deal. This ideas are

provided as an equilibrium solution for the developed model which describes the issue-invest

decisions. The model also gives the rational explaination of some particular behaviour of the

acquirer, such as the usage of the internal financial sources and the preference of debt increase in

case of needed external financing. Interestingly, the same result was later on obtained

empirically by many authors, for example, by Alberta Di Giuli /3./ We will introduce this

research in the following sections, but it's necessary to note that findings of the article prove the

influence of market misvaluation on the choice of the mode of payment. It's often the case that

the market has very positive expectations about the future performance of the acquirer, and

consequently it overvalues the stock of the acquirer. While there's an information asymmetry, the

M&A deals are paid in stock.

Another aspect that was covered in the paper of Mayers and Majluf is the effect of the

information asymmetry regarding the target. Basically, it says that if the acquirer is not sure

about the fair value of the target, it prefers to use the stock by means of payment. In case if the

target was estimated incorrectly, the market would immediately value it less, than before. It's

equivalent to the decrease in the value of the stock of the acquiere right after the deal announced.

The new shareholders (former target owners) would get less paid in this case.

One more interesting paper which describes the problem of information asymmetry in the

context of M&A deal financing is the actricle of Robert Hansen /7./. This paper also uses mostly

theoretical approach to address the question. However, some empirical estimation of 106 deals in

the USA during 1976-1978 is also provided, which prove the theoretical results. In this paper the

author uses the special terminology as medium of exchange, which basically means the

method of payment chosen by acquirer. It shows that if there's an information asymmetry about

the fair value of the target, the acquirer tends to minimize the risk of valuation by chosing the

proper medium of exchange. The authors refer to the standard game theory approach, which says

that the target would take the cash payments only in the case if it is larger than its private

valuation. Otherwise it rejects and the deal will not be completed. Thus, in case of cash

payments there's a substaintial probability of adverse selection and exessive payment, while in

case of stock payment the target shareholders have the same incentives as the acquirer to prevent

misvaluation by the market.

The interesting development of this topic can be applied to the emerging markets, most of

which suffered from the political and economic transformation in the recent years. Thus, many

17

Chinese authors address the issue of the presence of information asymmetry due to the lack of

accounting transparency. Particularly, Boateng and Bi pointed out that there's still a problem of

accounting conversion from Soviet-style to the Westen-style (IFRS). This financial reporting

transformation leads to the increase of information asymmetry. Despite the fact that it should be

only temporary issue, in many emerging economies it leads to the great information asymmetry

between the parties involved in the M&A process.

A substaintial coverage of the theory of information asymmetry let us to move to the

theory of investment opportunities.

The investment opportunities

Initially, this topic was introduced by Stewart Mayers /10./. The author proposed the

following idea about the deal financing. Basically, the acquirer may have several investment

opportunities, where M&A deal is only one of them. Consecquently, if the acquiere foresees tha

future investments, it would prefer to safe the cash in order to pay by cash in the future, while it

chooses to finance the M&A deal by means of stock. Such strategy lets the acquirer to prevent

the incsease in credit ratios, which is essential for easy borrowing in different financial

institutions. After Mayers, many researchers tend to find the evidence of this theory in empirical

studies. However, this is quite hard to make the difference in conclusions for both information

asymmetry theory and the theory of other investment opportunities, because the empirical

research requiers to use almost the same explainatory variables for both theories proof. These

variables are Book-to-market value, Tobins Q, etc. For the case of investment opportunities,

these variables should increase after the deal completion.

However, in quite recent papers the authors found the solution for the indentification

problem. We already mentions the paper of Di Giuli (2007), but now it is the time to provide

more details. Basically, the author proposes to separate the proxy variables for two different

theories. For the investment opportunities motive she offers to use the indicator of actual capital

investments in the period of 4 years after the M&A deal completion, while for the asymmetry of

information aspect she prefers to use the indicator of Book-to-market value. The last one

supposed to indicate the present of misvaluation. In more recent studies there was a valid

theoretical explaination of why the data on actual capital investments can be used as a proxy for

the presence of other investment opportunity for the company. Then Di Giuli empirically tested

the effect of post-merger investments on the chioce of the mode of payment. She collected the

data on 1642 M&A deals in USA during the period of 16 years (1984-2000) and found that

actually the large posr-merger investments positively influence on the choice of stock as a

method of payment. In more recent paper /4./, Di Guili studied this question again, with another

18

sample in 1187 deals during 15 years (1990-2005). Again, she found that the presence of

investment opportunities lead to the deal financing through the equity. One interesting extention

which one can notice in this paper is clarified incentives of the target to be sold to the overvalued

acquirer. Basically, the estimation showed that target managers are very interested in the long-

term performance of the acquirer and perceive the high quality of the deal. Due to these reasons,

the target agrees to the deal with overpriced counterparty.

After analysing these two theories in the previous literature, one might move to another

theory, which are even more vital for the emerging markets - the theory of financial resources

availability.

Availability of financial resources

This theory bases on the assumption that quite often many companies have a limited

number of financial resources, and it should form the financing approach according to its

abilities. For example, the cash can be obtained by either larger revenue or by the means of a

loan from the bank. Thus, the amount of cash depends on many factors, which is difficult to

manage. The company can not suddenly increase the revenue. It also can not get a huge loan

with quite low interest rates without the special treatment from the bank. Thus, one may

conclude that most often the amount of available cash is very limited. Consecuently, the

companies have to borrow the funds from the bank. Nowadays, many companies see no reason

to increase the debt ratio. Another reason is the lack of administrative resource to get a loan on

good terms. Due to these reasons the acquirer may prefer to pay in stock for a target.

However, the companies differ by the ratio of total cash to total assets. So, the size of this

ratio may influence the choice of the method of payments. Another indicator which should be

carefully treated when checking this hypothesis is the level of diversification of the company.

Its most likely that well-diversified company may aggregate more free cash due to easier access

to the debt market. The empirical studies in this field suggested the following results. In the

paper of Faccio and Massulis /6./ one might find the evidence of positive link which was tracked

between the size of the assets and the payment in cash for a target. In line with this result, the

author found the negative influence of high debt ratio on the payment in cash. Despite the fact

that the sample of the authors contained only European countries for 3 years (1997-2000), one

might pay attantion to the one interesting finding of the authors, which also can be addressed to

the emerging markets. Basically, the authors say that a privileged access to the cheap financing

increases the probability of equity financing. The authors point out that privileged access is

oftenly available to the state-controlled companies with the government on board.

These theories can be used in line with the idea of state ownership when we study the

19

M&A deal structure in the context of the method of payments.

Addressing the question of theimpact of state ownership on the acquirers performance:

the direct one and the indirect one (via the method of payment)

o the indirect impact of state ownership of the acquirers performance

The paper one would like to view in detail is the article of Agyenim Boatengand

XiaoGang Bi/1./. It's necessary to say that the Chinese economy is also related to the emerging

markets. Moreover, it's political and economic sittuation was very close to the former USSR. In

the previous decade, the Russian economy had a lot of substaitial reforms, same as the Chinese

one. So, most of the studies conducted for the Chinese M&A market can be used as a plentiful

base for the studies around Russian M&A market. Particularly, the authors of this paper studied

the mode of payments in M&A deals in two different aspects. First, they studied the difference in

the abnormal returns of the acquirers stock in case of paying in cash and stock using the

indicator of buy and hold returns. At the second stage, when the major effect of the method of

payments on the stock returns was clear, the authors studied the effects of the characteristics of

an acquiring companies on the mode of payment used to finance the acquisition.

The motivation of this research is quite interesting and very practical. During almost 30

years the scholars all over the world investigate the effect of different method of payment on the

acquirer's stock returns. Many of the researchers tend to exploit the hypothesis of asymmetric

information,which are hold by the acquirer and the target concerning the value of the company,

in order to explain the duality of choice in payment method (cash or stock). But most of these

studies cover the mature economies, while the emerging markets are still not studies enough. It

should be the case that M&A on emerging markets are quite different from the ones in mature

economies in the sense of impediments such as various government policies. It may be the

reason of financial segmentation, which let to the incorrect pricing of the target. Despite the fact

that Chinese government has undertaken many reforms, the financial insitutions remain

imperfet.It also grows fast: since 1998 untill 2011 there were almost 23 750 deals completed in

China.

The researchers hypothesised that the choice of the method of payment should depend on

the objective and subjective factors. We already addressed several hypotheses, which attempt to

the quiestion of choosing cash or stock as a method of payment. This paper would be considered

as an empirical research which continues and developes the theoretical studies. The authors

assumed that it can be determined by such explanatory variables as the Tobin's Q, the size of the

leverage, the market value of the acquiring company, the presense of partial ownership of the

company by the state and some other finanical indicators. For some of the factors there was an

objective evidence. For example, from the previous research in this field it's known that the

20

Chinese companies normaly have quite low debt ratio, which allows them easy borrowing for the

deal financing.This situation naturally stimulates the companies to pay in cash. But the other

indicators influence is much less obvious. For example, the state ownership may have an impact

on the decision on the method of payment. The authors provide the statistics concerning the size

of state-controlled sector in China. Despite the financial reforms that were done in the previous

decade, therere 80.1% of Chinese companies which have are partially or completely owned by

the state. One may reasonably assume that the close link to the government may result in the low

cost borrowing from the state-controlled banks. Unlike the Russian trend to nationalization, the

Chinese government tends to expand the influence of Chinese companies outside the country,

saving the control under these MNC. This is closely coincides with an idea of national

champions in China. Consequently, such companies would offer the cash much more often than

stock as a means of payment in order to prevent the dilution. Finally, the regression analysis

done by the authors showed that such factors as Tobin's Q, the size of the leverage, acquirer's

market value, the presense of state ownership positively relates on the cash as a deal's financing

offer.

Due to the second part of the authors research, one may consider the comprehensive

approach of analyzing the M&A performance dependent on the method of payment. It's very

important to estimate the long-term performance of the stock of the acquirer during the period

after the bid. This approach assumes the using of buy and hold abnormal return method along

with calendar time approach. The authors collected the data set which contains the bids of the

deals completed by Chinese based companies particularly in the mainland China during 1998

2007 yrs. Thus, the total sample contained 23 311 domestic M&A transactions. Moreover, this

data set contained the information on the deals' details, such as the date of announcment, the date

of completion and the chosen method of payment.

Th authors estimated so-called buy and hold abnormal returns variable (BHAR) for each

acquiring company, applying the different benchmarks to the reference portfolios.

Difference in Buy and Hold abnormal returns (BHAR) due to the method of payment

All Cash Share

Benchmark 1 BHAR 12,21% 14,24% 8,85%

Benchmark 2 BHAR 13,28% 15,31% 8,47%

Benchmark 3 BHAR 6,12% 6,50% 29,37%

Table 4.Source: [1]

21

The results obtained by the authors suggest that for the period before the bid the BHAR is higher

for the companies which finance the acquisition through the stock than the cash. Since the

authors investigated the different length of pre-bid period (1 and 3 years before the bid), the

results are found for both of these peroids. In both cases the companies which have equity

financing do outperform the companies which finance the deals through cash, which can be seen

from the table 5. The authors found the proof of the hypothesis that the companies prefer to

finance the deals by the stock in the presence of high asymmetry of information since theres a

few disclosure on financial markets. The same can not be said for the post-event period theres

no absolute proof.

The direct impact of state ownership on the acquirers performance

The very important note should be provided here, which was stated by the authors of the

previous research. They suggested to extend the research by adding more governance variables

to this model in order to clarify the reasons, which can motivate the companies to finance the

deals by either cash or the stock. Thats what exactly can be done in this paper in the context of

future research. In the Methodology section one will construct the similar research plan with the

only one difference: the influence of the state ownership will be directly included in the

estimation of M&A performance. The good motivation of such variation was provided in the

paper of Min Du and Agyenim Boateng /5./ along with Bilei Zhou et al. /15./. Parlicularly, in

these papers, the authors mainly address the question about influence of state ownership on

domestc and cross-border M&A. Both authors emphasize the importance of this studying since

its poorly covered in the world literature on the topic of M&A in emerging markets.

Following by Du and Boateng, one may consider the reasons why is it interesting to

investigate the effects of state ownership along with another institutional variables on the stock

returns of the acquirer. This is an application of an institutional theory in the M&A field of

research. As in any theory, there are both pros and cons for the participation of the government

in the ownership of the company.

Some researchers consider the state-controlled companies as inefficient comparing to the

private companies because the government may try to pursue the political rather than economic

purposes when ruling the company (for example, it seeks to support full emplyment, rather than

maximize the profit). Another reason why the company can be inefficient under the state

ownership is the fact that such companies ususally have the high level of bureaucracy, which

leads to the problem of information asymmetry. We already saw the negative consequences of

severe information asymmetry. However, therere another point of view on state-controlled

companies. Back to the M&A discussion, one might note that the government tends to help

owned companies by inducing the tax rebates, financial assistance and soft lending. From

22

empirical research of 20000 Chinese-listed companies one may note that state-owned companies

faces a fewer financial constraints. It can be easily concluded that the market perceives such

companies as the ones with economic and political anvantages, which is therefore reflected in

the price of stock of the acquirer. Nevertheless, the effect of state ownership on the acquirers

performance is still controversial and should be studied for particular market in a greater detail.

23

Section2.3. Methodology

That is the time to move to the empirical research on the question of the state ownership

and M&A deal structure. The empirical part will be organized in the following way. It will

consist the two separate parts, each of them addresses the impact of state ownership on various

aspects on the deal structure.

1. one will examine the effect of state ownership on the choice of payment method

along with another variables, which are the important indicators for another theories.

This part has very close methodology to Boatend and Bi (2014).

2. It would be interesting to track the influence of the deal structure on the M&A

performance, how it was done in paper of Boateng and Bi (2014), but one would

prefer to study the direct impact of state ownership on the M&A performance in the

context of short-term and long-term. Such turn will be guided by thepaper of Du and

Boateng (2015), where the methodology is very close to the one which will be

developed here.

Part 1: the determinants of the method of payment

First of all, one should determine the explanatory variables and hypothesize about its

possible influence on acquirers choice of payment method. Following the theories which can

explain the difference in payment method discussed earlier, one would introduce several control

variables, which should be included into the model in order to prevent the biasness of the results.

The note is that all the following variables are assumed to be calculated for the acquirer, if

nothing other is said.

The main explainatory variable one would have a special attention is the state ownership.

Since it is already said that the government participation in fact can create an advantage for the

acquirer by means of low-cost loan and many other indirect assistant services, following the

theory of availabilty of financial resources, one would included this variable in the model,

measured as a percentage of shares owned by the government (either federal, refional or local).

Theres list of the ministries published in an open government electronic resource which

contains the information on the state departments which has a shares in the particular (named)

companies. This information can be added to the list of all M&A deals which meet the

requirements described later on.

H1: The greater the share of the of the state in the corporate ownership structure

positively related to the payment in stock.

Due to the information asymmetry, one would use the Tobins Q ratio. The particular

definition is provided in the table. In fact, the Tobins Q ratio reflects the market valuation of the

24

company. In the previous research it was revealed that the company with higher Tobins Q ratio

more often pay in stock than in cash. This suggestion forms the first hypothesis:

H2: The company with higher Tobins Q will be more likely to pay in stock for a target.

Following the theory of insvestment opportunities, one might choose the amount of the capital

investment in post-merger period as an indicator of for this aspect. The data on the capital

expenditures in the following period should be manually collected for the necessary companies.

The period is cut up to 2 years. Otherwise it can be the case that the management of an acquirer

would have enough time to recover after the M&A deal in order to invest in something else.

H3: The acquirers which have alternative investment opportunities more likely pay in

stock.

Short label of

the variables

Full name of the

variables

Description Theory

referenced

StateOwn State ownership

Availability

of financial

resources

Leverage Leverage ( )

Availability

of financial

resources

TobQ Tobins Q ratio ( + )

Asymmetry

of

information

CapEx Capital investment ( 2 )

Investment

opportunities

LnRelatSize Logarithm of Relative Size ln

1

Controls

Diversif Diversified deal

1, 0,

Controls

LnAssets Logarithm of Assets

Controls

The dependent variable is obviously the method of payment the binary variable which

is equal to 1 if the payment was in stock, otherwise 0. Thus, the regression model which will be

estimated looks as follows:

= 0 + 1 + 2 + 3 + 4 + 5

+ 6 +

The population will be obtained from the database of the M&A deals with Russian-listed

companies Zephyr (Bureau Van Dijk). For the second part the empirical section one essentially

25

needs the data on the stock returns. This data can be obtained from the Bloomberg database or,

even better, the Thomson Reuters database (SDC). The sample should be carefully sorted out

from the population following the restrictions mentioned therein:

1. The data about the company should contain the information about the price of the stock

and some financial (acconting) reports.

2. The acquirer should be involved in one deal process only. The multiple acquisitions must

be excluded. Otherwise one would not be able to separate the effects of different

acquisitions.

3. The data should contain the information about the date of announcement and the date of

completion. The information about the bid should be available.

The period of sample will be 12 years (2002-2014). We expect to obtain the sample of the

size approximately 1500 observations. First, one will prepare the descriptive statistics, analyse it.

Then one will use probit class of models and also check for robustness.

Part 2: the impact of state ownership on M&A performance

One may note that this approach is power-driven and it needs to use the powerful

statistical software. BHAR basically is the actual returns during the event window, which

includes the period of 36 months after the bid minus the benchmark portfolio return. One would

refer to the previous research in this field to address the issue of the measurement of investors

investment experience by using the BHAR indicator.

The return of the company after the merging:

, = 1 + , 1

+

=

, - the return of stock i in month t

The benchmark reference portfolio return:

, = 1 + ,

+= 1

=1

the number of stocks in the portfolio in the beginning of the month s.

T the length of the period of holding the stock (36 month)

= 1 + , , 1

+

=

- buy and hold abnormal returns during 3 years after M&A deal.

The next step was to construct and estimate the benchmark portfolios, which were

complied in a special way. There were three kinds of the benchmark portfolios: the size decile

26

reference portfolios, 50 size/ Book-to-Market value reference portfolios and the most

complicated one the size, Book-to-Market value and Industry control portfolio. One may

require the particular way of constructing these benchmarks, since it was created in a detailed

and accurate methodolody. One might provide a step-by-step explaination of the construction

method in order to use it in the future own research.

The size decile reference portfolios:

1. Download the data on the market capitalisation of the tradable companies from the

sample.

2. For the beginning of each year range the companies by the market capitalisation in the

decending order to form 10 size deciles, where the first decile has the companies with the

largest capitalisation and the last decile represents the companies with the smallest

capitalisation.

3. Calculate the return of each company from each decile for each year during the period of

(-36 month, + 60 month) from the January of the particular year (for example, 2006).

4. Combine the sample of reference portfolios and the sample with actual returns during the

event window (-36 month, +36 month) starting from the month of event window for

actual returns and finally calculate the buy and hold abnormal returns.

Quite similar procedure is used for construction of 50 size/ Book-to-Market value reference

portfolios. The companies are now ranked by quintiles in acsending order by the indicator of

Book-to-Market value, starting from the most glamorous companies, which have the lowest

BTMV ratio. Combining this ranking with the ranking by the size of market capitalisation, one

would get (10 deciles * 5 quintiles) 50 size/ Book-to-Market value reference portfolios. Then

again one combines whis modified sample with the actual returns in the event window, starting

36 month before date of the bid. The last type of the benchmarking - the size, Book-to-Market

value and Industry control portfolio is the mix of the second benchmark portfolio with

additional requirement for the companies to belong to the same industry group.

Finally, the one would presend the regression model:

= 0 + 1 + 2 + 3 + 4

+ 5 + 6 + 7 + 8

+ + +

where StateContrAcq is the dummy, which equals to 1, if the acquirer is state-controlled

company and analogically StateConrtTarg is the dummy, which equals to 1, if the target is state-

controlled company.

28

Part3. Conclusion

In this extended proposal one analyzed the impact of state ownership on the M&A deal

structure.The particular example of the political connections and corporate governance can be

seen in Russia. Like in many other emerging economies, theres a strong influence of the state on

the investment decisions taken by the private companies. In many cases such state-controlled

firms drive the M&A market in its sector. This behaviour is twofold. On one hand, it moves

economic activity in the country. On the other hand, it lead to the expansion of state control over

the pure private sector. More formally, such actions demonstrate nationalization motives.

However, one would be interested in the details of the deals with state-controlled

companies involved. Therere several issues that should be addressed by the management of the

company before the procedure of merger has started. One would be more precise about the

method of payment chosen by the company. According to the theory of availability of financial

resources, the state ownership might have a significant impact on the preference over cash as a

payment method. However, therere another theories that should be considered when doing

empirical estimation, such as the theory of information asemmetry and the theory of investment

opportunities.

Another characteristic of the M&A deals is the performance of the acquirer after the deal

announced. This section found a great coverage in the world literature around M&A topic. The

most relevant examples can be taken from the M&A practice in China, since its political

situation has a lot of similarities to the Russian economy in the sense that it was pure socialistic

in the past. One might estimate the long-term performance of the acquirer by the buy and hold

abnormal returns. The regression analysis would indicate the effect of state control on the

performance of the acquirer.

Following the methodology presented earlier, one would expect the positive effect of

state control on the choice of cash as a method of payments. It coincides with the results of many

authors who did empirical research both on the mature and developing markets. One would also

expect to find the significant difference in the abnormal returns on acquirers stock for the pure

private and state-controlled companies. The sign of the relationship is difficult to predict at the

moment.

Finally, the completed research after this proposal should necessary contain carefull data

mining, sample collection and strong econometric techniques. The results of estimation should

be verified by the tests on typical econometric problems like heteroskedastisity and

multicollinearity. Overall, this research will be very useful both for the scholars and the

29

managers, since it reveals the actual particularities of M&A deals in the presence of a state

controll.

30

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2

10 largerst M&A deals in 2014

# The object of transaction

Sector Type of the

deal Acquirer Target

Acquired Share

(US$ mln)

Comments

1 "NNK-Aktiv" Oil & Gas merger Alliance Group/"NNK"

Alliance Group/"NNK"

joint company

60:40

6000 horizonal integration + economy of

scale

2 "Stroygazkonsulting" Transport & Infrastructure

acquisition Private investor Ruslan Baysarov

Private investor Zyad Manasir

44% 5000 strategic investment

3 "NNK-Aktiv" Oil & Gas acquisition "NNK" Alliance Group 60% 4200 horizonal integration + economy of

scale

4 "TGK-9" Energy & Utilities acquisition Volzhskaya TGK KS-Holding n/a 1844 Reorganization, vertical

integration

5 USM Holdings Ltd Metals & Mining acquisition Management of USM

Private investor Alysher Usmanov


6 UgraGazPererabotka Oil & Gas acquisition SIBUR Holding Rosneft 49% 1600 Rosneft sold secondary

manufacturing

3

7 Polyus Gold International Ltd

Metals & Mining acquisition Private investor Oleg Mkrtchan

Halyard Global Ltd 19% 1584 strategic investment

8 Vkontakte Media & Telecommunications

acquisition Mail.ru Group Ltd United Capital Partners Advisory

48% 1470 Diversification motives

9 Altimo Media & Telecommunications

acquisition LetterOne Group Private investor Gleb Fetisov


10 AltynAlmaz Gold Ltd Metals & Mining acquisition Polymetal International plc

Sumeru Gold BV; Sumeru LLP

100% 1119 extension of resourse base

Note: the largest deal of 2014 was basically the series of M&A deals between 2 companies - NNK and Alliance group.

Initially, NNK acquired 60% of Alliance Oil, the subsidary of Alliance Group.

Then NNK merged with partially owned Alliance Group to create a joint company.

Table 1. Own calculations.

2

Plot 3. Source [8]

0 5 10 15 20 25 30

Oil & Gas

Real estate & Reconstruction

Transport & Infrastructure

Energy & Utilities

Metals & Mining

Media & Telecommunications

Consumer sector

Banking & Insurance

Innovations & Technologies

Agriculture

Other sectors

US$ bln

Total value of deals in different industries (US$ bln)

2014 2013