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Mergers and Acquisitions-Tax impact and valuation
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Roles of Management Graduates in Mergers and Acquisitions
By
Prof. Augustin Amaladas M.Com.,AICWA.,PGDFM.,B.Ed.For IMIS Bhubaneshwar
28/04/08 –at 9.20 AM
Issues related to Mergers and Acquisitions. Direct Tax implications Sales tax implications Foreign Direct investments Method of valuation Anti Trust Act Financing of Mergers and Aquisitions Role of Investment Bankers Accounting of Mergers.
Recent Mergers and Acquisitions HORIZONTAL MERGER As Ford announced the sale of the two British
iconic cars to Tata Motors Ltd.for 2.3 billion. Ford acquired Jaguar for $2.5 bn in 1989 and
Land Rover for $2.75 bn in 2000 but put them on the market last year after posting losses of $12.6 bn in 2006 - the heaviest in its 103-year history.
The Hutch and Vodafone merger
Vodafone(Briton)A Foreign company
HTIL(Whampoa group of Li-Ka Shing.
Hong KongA foreign company
Hutchison EssorIndian Company
67%
Takes over
Asim Ghosh-12%A.Singh and other companies
(Minority)
Essor group
INCOME TAX RELATED ISSUES FOR AMALGAMATIONCONDITIONS OF AMALGAMATION UNDER INCOME TAX ACT SEC 2
(1B)1. ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE
THE ASSETS OF THE TRANSFREE CO.2. SHARE HOLDERS HOLDING NOT LESS THAN 3/4TH IN VALUE
OF SHARES OTHER THAN SHARES ALREADY HELD SHOULD BECOME SHARE HOLDERS OF AMALGAMATED COMPANY
EX. NO. OF SHARES OF Altd CO. 1,00,000 NO. OF SHARES HELD BY Bltd IN Altd IS 20,000 NOMINAL VALUE OF SHARE IS RS.10 ASSUME Altd MERGE WITH Bltd THEN 75% OF 1,00,000- 20,000 =
60,000 TO BE THE SHARE HOLDES OF B CO.NOTE:SHARE HOLDERS MAY BE EQUITY OR PREFERNCE SHARE
HOLDERS
OTHER CONDITIONS THE AMALGAMATED CO. IS AN INDIAN CO.EXCEPTION1. IF SHARES OF INDIAN CO.HELD BY FOREIGN BEFORE
MERGER AND SUCH FOREIGN CO. TAKEN OVER BY ANOTHER FOREIGN CO.
2. ATLEAST 25% OF THE FOREIGN CO. (BEFORE MERGER) TO BE SHARE HOLDERS OF THE NEW FOREIGN CO.
? WHAT IS THE BENEFIT TO THE AMALGAMATED CO. AMALGAMATING CO.(OLD CO.)
NO CAPITAL GAIN ON TRANSFER ON CAPITAL ASSETS BY THE TRANSFEROR CO. UNDER SEC 47(VI) OF I.T ACT
? CAN NEW CO. CARRY FORWAD AND SET OF LOSS AND DEPRECIATION
SEC 72 A TO BE FULFILLED1. ACCUMULATED LOSSES REMAIN UNABSORBED FOR 3 OR
MORE YEARS2. 75% OF BOOK VALUE TO BE HELD ATLEAST FOR 2 YEARS
BEFORE AMALGAMATION3. THE AMALGAMATED CO. CONTINUES TO HOLD 3/4TH OF BOOK
VALUE ATLEAST FOR 5 YEARS4. NEW CO. SHOULD CONTINUE FOR ANOTHER 5 YEARS5. NEW CO. SHOULD ACHIEVE ATLEAST 50%OF INSTALLED
CAPACITY BEFORE END OF 5 YEARS AND SHOULD CONTINUE FOR 5 YEARS
A LTD AMALGAMATES WITH B LTD AS ON 1st April 2008
PARTICULARS DOES NOT SATISFY SEC 2(1B) & 72 A
SATISFIES 2(1B) BUT DOES NOT SATISFY 72 A
SATISFIES BOTH 2(1B) & 72 A
A MERGES WITH B (A GOES OUT)
NO BENEFIT TO A & B
DOES NOT ATTRACT CAPITAL GAIN FOR A BUT NO GAIN FOR B
NO CAPITAL GAIN TAX & ACCUMULATED LOSSES & UNABSORBED DEPERICIATION CAN BE CARRIED FORWARD
? If B merges with A . If B goes out of market who gains under above 3 situations
? If A&B merge with c. what are the tax implication under above situations?
. Assume B is a loss making co. Can accumulated losses & unabsorbed depreciations be carried forward and set off by the new company?
? If C is not an Indian co?
Tax Concession To Share Holders Of Amalgamating Co.
No capital gain tax provided, new co. is an Indian co.& Shareholders are acquired everything in shares
EXERCISE
PARTICULARS CO. A CO. B
EAT 1,40,000 37,500
NO. OF SHARES 20,000 7,500
EPS 7 5
MARKET PRICE 70 40
P/E RATIO 10 8
Co. A is acquiring co. B. Exchanging one share for every 1.5 shares of B Ltd & P/E ratio will continue even after merger
? Are they better or worse of than they were before in merger
?? A is an Indian co. ? A is a foreign co.? A merges with T & formed a new co. AT ltd? What are the tax planning required before &
after merger
CONCLUSIONS EXCHANGE AT EPS – NO EFFECT ON EPS
AFTER MERGER EXCHANGE MORE THAN EPS RATIO –
COMPANY WITH LOWER EPS GAINS IF LESS THAN EPS RATIO – COMPANY
WITH HIGHER EPS BEFORE MERGER GAINS
CONCLUSION IF SHARES ARE EXCHANGED BASED
ON CURRENT MARKET PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT HIGHER RATE THAN EXCHANGED BELOW THIS RATIO
Boot strap effect
CONCLUSION FIRM WITH HIGHER P/E RATIO CAN
ACQUIRE FIRM WITH LOWER P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET VALUE AFTER MERGER
Conclusion Fulfill section 2(1B) of Income tax act by transferor company Amount to be in the form of shares No cash to be received Foreign Direct investments in selected sector can not exceed 74%
by foreign company Fulfill section 72A of the IT act so as to reap the benefit by
transferee company Shareholders can not transfer their holdings with in 5 years. Sales tax at the rate of 8% can not be avoided. Set off and carry forward of losses is possible. What are the losses can be carried forward and set off? How
many years?
Some Facts-USA Companies 1897-1904-horizontal Mergers Monopolistic Market structure Mega merger between US Steel and
Carnegie Steel.It also merged with 785 separate firms-75% of Steel production of US.
As a result: ???? What happened to Standard Oil?
Standard Oil(SO) Broken in to 30 Companies. Some of them are SO of New Jersey named EXXON SO of New York named MOBIL SO of California renamed CHEVRON SO of Indiana renamed AMOCO What is ANTI TRUST Act? What is known in
India? HCL was formed?
HCL Hindustan Computers, Hindustan
Reprographic, Hindustan Telecommunications and Indian Software Ltd.
In February 2008, as many as 38 cross-border deals were announced with total value of $2.80 billion, of which 27 were outbound deals with a value of $2.57 billion
.In March 2008 it has crossed $10 billion in investment by Indian Companies outside India.
Diologic Meanwhile, global financial information provider
Diologic in its latest report said that India-targeted M&A volumes reached $11.9 billion through 345 deals so far this year. US was the leading acquiring country with deals worth 1.6 billion dollars, followed by the UK with $904 million and Germany with USD 584 million.
Some Facts Between 1926 and 1930- there were 4600
mergers took place Result of which between 1919 and 1930 12,000
companies went out of market. The second wave came to an end when
stock market crashed on October 29,1929.
Investment Bankers played in the first two phases of mergers.
1965-69 in USA Management principles were applied in
industries. Management graduates were employed to manage
conglomerate mergers. There were 6000 mergers which leads to 25000
firms disappeared. Investment Bankers do not finance most of these
mergers Finance:-????
Equity financing
EXERCISECOMPANY A NO. OF SHARES 2
LACS MARKET VALUE
PER SHARE RS.25 EPS RS.3.125
COMPANY B NO. OF SHARES 1
LAC MARKET VALUE
RS.18.75 EPS RS.2.5
PRICE EARNING RATIO APPROACH MEANING COMPUTATION : P/E RATIO = MP/EPS EPS = EAT/NO. OF EQUITY SHARES MARKET PRICE = P/E (NO. OF TIMES)
* EPS
EXAMPLEPRE MERGER SITUATION
FIRM A FIRM B
EAT 6,25,000 2,50,000
NO. OF SHARES 2,00,000 1,00,000
EPS 3.125 2.5
P/E RATIO(TIMES) 8 7.5
MARKET PRICE PER SHARE(MPS)
25 18.75
TOTAL MARKET VALUE (N*MPS) OR (EAT*P/E RATIO)
50,00,000 18,75,000
CONCLUSION IF SHARES ARE EXCHANGED BASED
ON CURRENT MARKET PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT HIGHER RATE THAN EXCHANGED BELOW THIS RATIO
Boot strap effect
MARKET VALUE AFTER MERGER = MARKET VALUE BEFORE MERGER = 68,75,000
NET GAIN = 15,00,000? IF EXCHANGE RATIO IS 2.5:1 WHO GAINS
WHO LOSES? IF EXCHANGE RATIO IS 1:1 WHO GAINS
WHO LOSES? HOW TO CALCULATE TOLERABLE SHARE
EXCHANGE RATIO
DETERMINATION OF TOLERABLE SHARE EXCHANGE RATIO
TOTAL MVLESS: MINIMUM TO BE GIVEN TO B
75,00,00010,00,000
NET BENEFIT TO A 65,00,000
NO. OF SHARES OF A TO A CO. SHARE HOLDERS
1,00,000
DESIRED POST MERGER MPS 65 PER SHARE
NO. OF EQUTY SHARES TO BE ISSUED BASED ON DESIRED MARKET PRICE
10,00,000/65 = 15,385 SHARES
TOLERANCE SHARE EXCHANGE RATIO
50,000/15385 = 3.25 SHARES OF FIRM B, 1 SHARE IN FIRM A 1:3.25
CONCLUSION FIRM WITH HIGHER P/E RATIO
CAN ACQUIRE FIRM WITH LOWER P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET VALUE AFTER MERGER
POST MERGER SITUATION 1(BASED ON CURRENT MARKET PRICE
SITUATION 2
EXCHANE RATIO/ SWAP RATIO (ASSUMING)
2.5:3.125=.8 1 : 1
EAT(COMBINED FIRM) 6.25+2.5=8.75 8,75,000
NO. OF SHARES 2.8 lakhs 2,00,000+1,00,000=3,00,000
EPS 8.75/2.8=3.125 8,75,000/3,00,000=2.91/
P/E RATIO(ASSUMED TO BE THE SAME)
8 7.5
MPS 3.125*8=25 21.825
TOTAL MARKET VALUE 70,00,000 65,47,500
ACCOUNTING FOR AMALGAMATION POOLING INTEREST METHOD CONDITIONS AS PER AS 14:1. ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO
BE THE ASSETS OF THE TRANSFREE CO.2. AT LEAST 90% OF F.V OF EQUITY SHARE HOLDERS
SHOULD BE SHAREHOLDERS OF NEW CO.3. PURCHACE CONSIDERATION TO BE SETTLED BY THE
NEW CO.4. THE BUSINESS OF NEW CO. SHOULD CONTINUE5. NO ADJUSTMENT IS INTENDED TO BE MADE TO BOOK
VALUE OF ASSETS AND LIABILITIES OF TRANSFEROR CO.
Life Education Abraham Lincolin
Thank You All.
Pricing of Capital issues Step-I Total assets Less: Preference Capital Secured and unsecured borrowings
Current liabilities Contingent liabilities---------------------------------------------------A.Net Worth---------------------------------------------------
Method II(Liability Approach) Equity Share capital Add: Free reserves ------------------------------- Less:- Contingent Liabilities---------------------------------------------Net worth--------------------------------------------
2.Profit Earning Capacity Value-PECV Weighted Adjusted Average Profit before TaxLess: Provision for Tax at %------------------------------------------------Weighted average profit after TaxLess : Preference dividend----------------------------------------------Net profit after Tax and dividendNumber of Equity shares including Fresh and bonus shares-------------------------------------------------------------------------EPSPECV= Capitalisation of Profit at 15%/12%/10%/8% respectively = Net Profit After tax and dividend*100/15
3.Fair value (Net Asset value +Profit Earning Capacity
Value)/2
4.Average Market Price Year I High Low Average Year II Year (Current Year) 4. Monthwise: 1
2 3 4 etc for 12 months (Average market price for the three years)
5. Capitalisation rate If MV not more than 20% of FV-15% If MV more than 20%-50% -12% Between 51-75 - 10% Above 75% - 8%
PE- Multiple Average P/E ratio of related companies areConsidered to discount