Mergers & Acquisition

Mergers and Acquisitions
Executive Summary:
Marriages in the corporate world, King of Corporate Marriages
These words seem to be flashing in front of our eyes day in and day out. One wonders why the importance to marriages. But the catchword here is corporate. Today marriage is the image associated with mergers or acquisitions. The word is not used only because it is in vogue or to attract attention. A marriage is the coming together of two people to become one, but each of them have their own individuality and in order to make the marriage a success compromises need to be made. This is also true for mergers and acquisitions. When two companies come together both of them have their individual work cultures and identities but in order to work together successfully they have to make some changes. Only then can a merger or an acquisition be successful. This is very simply put. However it is not so simple, nor is it just a matter of making changes. In fact there are a lot of things that go into making a merger successful. These are the issues that one needs to take care of while going in for a merger or an acquisition The first chapter of this report seeks to explain what the various terms used to classify the coming together of two corporations means. There can be various types of mergers namely horizontal, vertical, conglomerate, concentric and consolidation mergers. There are certain terms that are peculiar to mergers and acquisitions like golden parachutes, greenmail and so on. These terms are explained in the chapter. One must understand why corporates decide to merge. Every organization has its own reasons but most of the reasons are common. They include cost benefits, economies of scale and growth. In a merger or an acquisition, the nitty gritty maybe worked out to perfection but there is still no guarantee that the merger will succeed. Hence it is important to look at some of the most common reasons that mergers fail despite the best efforts put in. One might feel that cultural integration of the two organizations is a must and it will be done but it is often overlooked, causing many mergers to fail. There are some problems that are likely to occur at every stage in the merger or acquisition process, an overview of most of the problems is given.
A merger can be friendly or hostile. If the merger or acquisition is friendly it has higher chances of success. Now we move onto the important issues that one needs to look at in order to be successful or in order to carry out a merger. It is imperative to carry out a due diligence process before the merger takes place since this helps the merging or acquiring company to assess the value of the target company. The due diligence must be thorough, only if the result is positive then one should continue the merger process. Communication with the employees, suppliers and customers is crucial. When a company is going through a merger or an acquisition process the people related to the organization tend to feel vulnerable. They have no idea what the outcome of the process will be and where they stand, hence it is important to constantly communicate with everyone who has an interest in the organization. Synergy is extremely crucial to a merger or an acquisition because that is what will ensure that the merger is a success. Synergy means that 2+2 > 4, which is to say that the companies must create a higher value together than they create when they are functioning on a standalone basis. Integration of cultures and people of the two firms is crucial for a merger or an acquisition. At the end of the day, it is the people at the lower levels who have to work together to achieve the forecasted synergies; if they do not work together then the merger cannot succeed. The revenues of the merged entity often play second fiddle to the costs. But one should realize that at the end of the day lack of revenue growth hurts the organization more than nailing costs. It is important that after the merger or acquisition process is complete, the firm reviews its price structures in view of the benefits that are now available to the customers. Failure to align the prices with the benefits may prove to be fatal for the organization. During the merger or acquisition process the company is most prone to attacks from competitors, since the firm is concentrating on its merging efforts and is not able to respond to the competitors campaign.
How does one determine the value of the target firm? In practice two methods are used the Discounted Cash Flow Method and the Trading Multiples. However the chapter explains a few more methods of valuation. After looking at all these issues it is important to study the success of mergers and what they are related to and the three main factors that one needs to consider in addition to the ones mentioned above. After having talked about mergers and acquisitions in general, I move onto giving an idea of why mergers and acquisitions are growing in India and the opportunities that are available for value creation. Companies may merge worldwide but when it comes to India, very often they do not get the same benefits that they get in other countries. This is due to various factors like size of the companies, legislation in India and so on. The Indian environment is not as merger friendly as it can be; a few ways in which to make India more merger friendly are given. For any deal there is always a law governing it, I have explained the take over code, which governs mergers and acquisitions in India in brief. My study would be incomplete if I did not analyze a merger. I have analyzed the merger of ICICI bank with Bank of Madura. At a glance one can find out why, the benefits and the problems that the merger is likely to face. In order to understand the practical aspect there is an interview that is enclosed towards the end.
Definitions
In the corporate world the coming together of two entities is termed many different things. It can be called a merger, an acquisition, a takeover, etc. In order to understand the various terms one needs to look at the definitions of these terms. However, it is important that these definitions are not taken as final. In commercial usage these terms are used interchangeably since there is no universally accepted definition for these terms. What they mean in legal parlance may not hold true in financial parlance. Even in legal terms different laws define them differently. The definitions are not rigid since the outcome of all of them, whether a merger or an acquisition, results in the same thing. It results in the existence of one company, whether newly formed or existing, which is stronger than the previous company or companies were. Despite this it is essential that one understands the meaning of each of the terms.
Merger: It is the combination of 2 or more companies into a single company

where one survives and the other loses its corporate existence. Generally the company who survives is the buyer. The survivor acquires the assets as well as liabilities of the merged company or companies. In commercial usage, absorption of one or more companies with another is termed as a merger. No new company is formed. However they say that a true merger in the legal sense occurs when both the firms dissolve and fold their assets and liabilities into a newly created third entity
Amalgamation: Halsburys Laws of England describe amalgamation as a

blending of two or more existing undertaking into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company which is to carry on the blended undertaking.
Consolidation: Technically speaking consolidation is the fusion of two

existing companies into a new company in which both the existing companies extinguish.
Mergers and Acquisitions Merger and Consolidation can be differentiated on the basis that , in a merger one of the two merged entities retains its identity whereas in the case of consolidation an entire new company is formed.
Acquisition: An acquisition is the purchase by one company of a controlling

interest in the share capital of other existing companies. This means that both the firms retain their corporate identity.
Takeovers: A takeover bid is the acquisition of shares carrying voting rights in a

company with a view to gaining control over the management. The takeover process is unilateral and the offeror company decides the maximum price.
Demerger: It means hiving off or selling off a part of the company. It is a

vertical split as a result of which one company gets split into two or more.
Different types of mergers:

Mergers are generally classified into 5 broad categories. The basis of this classification is the business in which the companies are usually involved. Different motives can also be attached to these mergers. The categories are:
Horizontal Merger: It is a merger of two or more competing companies,

implying that they are firms in the same business or industry, which are at the same stage of industrial process. This also includes some group companies trying to restructure their operations by acquiring some of the activities of other group companies. The main motives behind this are to obtain economies of scale in production by eliminating duplication of facilities and operations, elimination of competition, increase in market segments and exercise better control over the market. There is little evidence to dispute the claim that properly executed horizontal mergers lead to significant reduction in costs. A horizontal merger brings about all the benefits that accrue with an increase in the scale of operations. Apart from cost reduction it also
Mergers and Acquisitions helps firms in industries like pharmaceuticals, cars, etc. where huge amounts are spent on R & D to achieve critical mass and reduce unit development costs.
Vertical Mergers: It is a merger of one company with another, which is

involved, in a different stage of production and/ or distribution process thus enabling backward integration to assimilate the sources of supply and / or forward integration towards market outlets. The main motives are to ensure ready take off of the materials, gain control over product specifications, increase profitability by gaining the margins of the previous supplier/ distributor, gain control over scarce raw materials supplies and in some case to avoid sales tax.
Conglomerate Mergers: It is an amalgamation of 2 companies engaged

in the unrelated industries. The motive is to ensure better utilization of financial resources, enlarge debt capacity and to reduce risk by diversification. It has evinced particular interest among researchers because of the general curiosity about the nature of gains arising out of them. Economic gain arising out of a conglomerate is not clear. Much of the traditional analysis relating to economies of scale in production, research, distribution and management is not relevant for conglomerates. The argument in its favour is that in spite of the absence of economies of scale and complimentaries, they may cause stabilization in profit stream. Even if one agrees that diversification results in risk reduction, the question that arises is at what level should the diversification take place, i.e. in order to reduce risk should the company diversify or should the investor diversify his portfolio? Some feel that diversification by the investor is more cost effective and will not hamper the companys core competence. Others argue that diversification by the company is also essential owing to the fact that the combination of the financial resources of the two companies making up the merger reduces the lenders risk while combining each of the individual shares of the two companies in the investors portfolio does not. In spite of the arguments and counter-
Mergers and Acquisitions arguments, some amount of diversification is required, especially in industries which follow cyclical patterns, so as to bring some stability to cash flows.
Concentric Mergers: This is a mild form of conglomeration. It is the

merger of one company with another which is engaged in the production / marketing of an allied product. Concentric merger is also called product extension merger. In such a merger, in addition to the transfer of general management skills, there is also transfer of specific management skills, as in production, research, marketing, etc, which have been used in a different line of business. A concentric merger brings all the advantages of conglomeration without the side effects, i.e., with a concentric merger it is possible to reduce risk without venturing into areas that the management is not competent in.
Consolidation Mergers: It involves a merger of a subsidiary company

with its parent. Reasons behind such a merger are to stabilize cash flows and to make funds available for the subsidiary.
Ways of handling a merger or an acquisition:

There are 4 ways in which a merger can be handled:
Friendly merger: a merger whose terms are approved by the

management of both companies. Usually such mergers have a high probability of success
Hostile merger: A merger in which the target firms management

resists the acquisition or merger.
Tender offer: The offer of one firm to buy the stock of another by going
directly to the stockholders, frequently (but not always) over the opposition of the target companys management
Proxy Fight: an attempt to gain control of a firm by soliciting

stockholders to vote for a new management team.
The M&A Terminology

There is a lot of imagery associated with mergers and acquisitions. Some of the commonly used terms are described here:
Spin-off: Spin-off has emerged as a popular form of corporate downsizing. A new

legal entity is created to takeover the operations of a particular division or unit of the company. The shares of the new unit are distributed pro rata among the existing shareholders. The shareholding in the new company at the time of spinoff will mirror the shareholding of the parent company. The shareholders now own shares in two stand-alone companies.
Leveraged Cash Out: A target company would issue debt instruments,

when facing a hostile bid. The cash proceeds would be used to finance share buyback, huge one time dividend and/or employee stock options. The leverage would become high and the target would become undesirable to the raider, due to the additional layer of risk involved.
White Knight: White Knight strategy involves selecting of a lesser evil.

White knight defense is affected when a firm is a target of a hostile tender offer. The target firm may invite another firm, called as the white knight, to make a counter offer for its share. The white knight may bid for the shares of the target at a price equal to greater than the hostile tender offer.
Poison Pills: The poison pill strategy involves issuing new securities, which
would be convertible into equity at a low price in the event of a hostile takeover of the firm. Such conversion would severely dilute the equity capital of the firm. These securities have no value unless an investor acquires a specified percentage of the companies voting stock, without the board approval.
Greenmail: Greenmail is a form of targeted share repurchase. It refers to the

repurchase of a block of shares from specific shareholder(s), at a substantial premium, to prevent a hostile tender offer on the company.
Golden Parachutes: Golden Parachutes are agreements that provide for

payment of huge severance packages to the senior management executives in case of takeover of the firm. The word Golden signifies the lucrative nature of the compensation payment. It covers a few dozen key employees of the company.
White Squire: This strategy entails the target company issuing a large block of
shares or convertible preference shares to a friendly party. This is done to dilute the stake of the hostile acquirer in the company by increasing the number of shares. Typically, the white squire is a portfolio investor and is not interested in gaining control of the target company.
Leveraged Buyout (LBO): This is an innovative way of financing an

acquisition, whether friendly or hostile. The acquisition financing is largely by way of debt and the equity component would be very low or negligible. The debt of the company would become too risky and the bonds would be traded as high-yield bonds or junk bonds in the market.
Reasons for Mergers and Acquisitions

The reasons for mergers and acquisitions automatically translate into the benefits that one derives from them. The reasons can be summed up as:
Essential Strategy: Companies are beginning to learn what nations have

always known; in a complex uncertain world filled with dangerous opponents, it is best not to continue facing it alone. In a world of rapidly globalising markets and industries a world of converging consumer tastes, rapidly spreading technology and escalating fixed costs, merger and acquisition is an absolutely essential strategy and is no more just trendy.
To maintain profitability: To assure profits, firms, which find

themselves in hypercompetitive environments, must narrow the field of entrants and shift competition back toward oligopolistic conditions where there are reasonable profits but not as high in the case of monopolistic markets. The swiftest way to do that is not to compete, but to cooperate; thus, the incentive to merge and consolidate.
High cost of set-up: Most people today want to use either IBM or
Compaq notebook PCs. There is no place for a new player to enter or even for a smaller player to continue in the market. The large players can utilize the facilities and distribution network of the smaller players better. To understand this better lets take a hypothetical case where GE is going to enter into the PC market it will make more sense for them to utilize the existing capacities of a smaller player or few smaller players by either merging with them or acquiring them rather than setting up everything from scratch.
Dispersion of technology: Technology becomes available to everyone,

as there is wide dispersion of technology. Thus time becomes a very critical factor. Any break-through in technology needs to be cashed in on in a short span of time, this can be done through large sales volumes. For that you need market access, finance and
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Mergers and Acquisitions information. So larger the company the better are the chances that you would have the aforesaid
factors in plenty. In the case of pharmaceuticals especially, it would save overlapping research and development if two companies merge.
Increasing importance of fixed costs: To compete in the global

arena, you have to incur immense fixed costs and in order to remain competitive one also needs to defray the fixed expenses across a large volume. Building and maintaining a brand is also a fixed cost. Even in the case of sales and distribution networks, firms try and go through dealers but they still have to maintain a sales force. In a fixed cost environment, the focus is on maximizing marginal contribution to fixed cost by boosting sales. This logic forces managers to amortize their fixed costs over a much larger base and this adds to the increasing passion among firms to grow in size. The fastest way to grow in size is to merge or to acquire.
Mergers
and
Acquisitions
and
its
relation
to
corporate strategy: Mergers and acquisitions should be seen in light of

their relation to maintaining or changing the balance of the firms existing domain and the renewal of its capabilities. Mergers and acquisitions can contribute to the corporate strategys in three ways: they can deepen the firms presence in an existing domain, they can broaden that domain in terms of products, markets, capabilities, or they can bring the company into entirely new areas. These can be explained in this manner: Domain Strengthening: mergers and acquisitions augment or renew the capabilities underlying a firms competitive position in an existing business domain. The most straightforward e.g. of this would be the TOMCO acquisition by Hindustan Lever. Domain Extension: mergers and acquisitions apply the firms existing capabilities in new and adjacent businesses or bring new capabilities into the firm to apply in its existing businesses. An example of mergers and acquisitions intended to add capabilities is Computer Associates
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Mergers and Acquisitions International, they became the largest independent software firm in the industry by acquiring many software houses. Each of these provided a
new type of programming capability that contributed to their ability to achieve its strategy of becoming a full-line software provider. Domain Exploring: mergers and acquisitions involve moves into new businesses that at the same time require new capability areas. The objective is to lever the industry-specific learning and the credibility from successful initial small acquisitions into a broader commitment to the acquisition and development of a more significant position in that industry. For example: entry of the Ajay Piramal group into Pharmaceuticals by acquisition of stake in Nicholas Laboratories and then subsequent acquisitions of Roche Products, Sumitra Pharmaceuticals, Boehringer Mannheim and merging all of them to form Nicholas Piramal India. This is similar to the concept of diversification.
Tax considerations: This has stimulated a lot of mergers and acquisitions.

For example: A profitable firm in the highest tax bracket could acquire a firm with large accumulated tax losses. These losses could then be turned into immediate tax savings rather than carried forward and used in the future. Also, mergers can serve as a way of minimizing taxes when disposing off excess cash.
Managers personal incentives: Financial economists like to think

that business decisions are based only on economic considerations, especially maximization of firms values. However, some business decisions are based more on managers personal motivations than on economic analysis. Many people, business leaders included, like power and more power is attached to running a larger corporation than a smaller one. Obviously, no executive would admit that his or her ego was the primary reason behind the merger, but egos do seem to play a prominent role in many mergers. The managers invariably argue that synergy and not a desire to protect their own jobs motivated the merger, but many observers suggest that many mergers were
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Mergers and Acquisitions designed more to benefit managers than stockholders. Hence this is also a major cause of failures of mergers.
Others: Mergers and Acquisitions are also done for the purpose of acquiring
capabilities or acquiring a particular business position or platform. In retrospect one can sum up the reasons with this statement: If all markets were equally accessible, all management equally skilled, all information readily available, all balance sheets equally solid, and there was availability of time to create sufficient physical infrastructure there would be little need for mergers and acquisitions.
Why they do not succeed?

Despite the popularity and importance of mergers and acquisitions among large and small firms, many mergers and acquisitions do not produce the benefits that are expected or desired by the buying firm. Some of the reasons could be:
High cost of financing: A study conducted by Mckinsey shows that 60%

of the acquisitions examined failed to earn returns greater than the annual cost of capital required to finance the acquisitions.
The potential for managerial hubris: This may preclude an

adequate analysis of the target firm or may produce substantial premiums paid for the firm that is acquired. In such a case the mergers and acquisitions may not be for the benefit of the company. An e.g. is Sonys $5 billion takeover of Columbia Studios in which Walter Yetnikoff, the CEO of Sony paid almost $800 million to acquire two producers from their contract at the Warner Bros. This was a part of the battle with the Warner Bros CEO, Steven Ross. Yetnikoff convinced his superiors at Sony that the producers would earn millions of $ for them. Unfortunately both of them set records for underachievement.
Failure to integrate: diverse cultures, structures and operating systems of

the two firms.
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Failure to do proper due diligence: during the pre-merger or

acquisition stage.
Bankruptcy of strategy: There is a strong belief that mergers and

acquisitions indicate a bankruptcy of strategy, an inability to innovate. CEOs in order to defend their merger plans are often quoted saying Only the biggest survive. This rationale is largely specious; size does not inoculate a company from rule-busting innovation. Thus lack of innovation is another reason for mergers floundering.
Employees of the organization:

The sought-after benefits of greater size and efficiency are nullified by increased losses related to top- heavy organizations which means that the people increase as a result the benefits etc provided to the top management also substantially increase. There are problems of: reduced job security, increased work loads, anxiety and stress all of which have a negative effect on the morale of the employees which in turn affects their productivity. If the employees and the culture of the companies are not integrated then this can be a major reason for the failure of the merger and acquisition
Anatomy of a merger and acquisition transaction

Pre-change stage
This stage is characterized by self-appraisal through objective evaluations and independent, consultations both internal and external on possible structures, which would be comfortable. Key issues to determine are quantum of control, key people choices such as CEO & CFO appointments, basis of deriving future valuations, depth
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Mergers and Acquisitions of due diligence exercises, time frames and legal safeguards. Generally, merchant/ investment bankers and lawyers along with firms of chartered accountants get involved
in the negotiations to create an appropriate deal structure. Finally, the entrepreneurs/ professional managers agree upon a deal, and an agreement is drawn up. Regulatory frameworks play a key role in consolidation. In the case of parent-subsidiary merger economic gain is not readily apparent because the merging firms are under same management even before the merger. Still the flow of funds between a parent and the subsidiary are obstructed by a lot of other considerations like taxation, etc. therefore consolidation can smoothen cash flows and also make it easier to infuse funds for the revival of sick subsidiaries.
Post- deal stage

This is the most crucial period in the history of both the amalgamating and the amalgamated enterprise. Cultures clash most severely. From an easy-going, parental culture to an aggressive accountability-seeking framework, various hues of culture exist in the corporate world. Managing a blending of cultures is perhaps the most complex and pain-staking process. Leadership style of the CEO, the communication strategy, the change of management choices all determine success or failure of this process. Intense communication, verbal, through videos, written and multimedia is important. There is bound to be a natural attrition in this phase. It must be managed humanely. Integration leads to several avenues for economy by either combining some functions or by the introduction of technology. Marketing and distribution areas pose unique challenges in the integration process. Identifying common and uncommon customer populations, deciding the best channels to access them through, sample distribution strategies and price and packaging strategies can all influence the course of successful change management. The customers need to be managed most effectively to ensure that the new enterprises full range of offerings can reach the correct audience; massive economies can arise from joint promotions, communalizing pricing strategies and intensely nurturing customers.
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Mergers and Acquisitions Production facility balancing and grouping like technologies for specialized manufacturing can release immense hidden value. Distribution efficiencies can also be dovetailed effectively if opportunities can be quickly identified. Redundant non performing assets are discovered for encashment. One can cover the entire cost of the merger in 1-2 years if such assets are found.
Problems at the various stages in the Merger or Acquisition process:

After the merger announcement
Typical problems Emotional roller coaster. Vacuum of information. A feeling of being in a void. There is no point in making new plans. Competitors talk negatively about your merger. Reduced sales. Specialists attempt to get to know their counterparts in the other company, but dont trust them. The threat of the merger results in a team bonding within each company. The beginning of an us and them mentality. Staff and the market want to know "whats happening."
Company led interventions Set up a communications committee comprising credible people from both companies. Find out what peoples concerns are. Listen. Try to stop the rumors by communicating honestly what you know AND what you dont know. Publish a state of the merger newsletter. Dont make any rash promises you cant keep to in the future. Example there will be no retrenchments.
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Mergers and Acquisitions Consultant led interventions External consultants could be used to help design the new structures and select people for key positions.
Creating a structure for the merged company

Typical problems A feeling of loss as teams are split up and merged into new team. Distrust of new team members. The new leadership team is not working effectively. Unclear roles. Resignations of key people. Some people who did not get the positions they expected feel resentful. Low morale. Rumors. The market responds negatively to the loss of key people.
Company led interventions Clarify structures. Clarify roles. Continue and intensify your communication program.
Consultant led interventions Team building. Role clarification exercises. Change management help people to understand what to expect from each stage of the merger, and how to cope with their emotions.
Gather information about each company.

Typical problems Lower levels still feel in a vacuum. They begin to jockey for position.
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Mergers and Acquisitions Them and us feelings intensify. Customers begin to ask for combined products and services. Competitors exploit the confusion.
Company led interventions Set up project teams to investigate what you have in each company in each functional area with regard to: Policies Procedures Products Services Systems Structures Brands Staff benefits IT Products & services. Project teams should also investigate what the' Worlds Best' are doing. Project teams should develop proposals of what the systems/policies/procedures for the new merged company should look like. Develop a program for implementing your new policies, procedures and structures. Keep communicating progress.
Consultant led interventions Consult with specialists on what the 'Worlds Best' are doing in terms of each project. (A merger is a good opportunity to start afresh.)
Merging the operations

Typical problems Stress (operational plus integration tasks have to be done simultaneously.) People complain the old was better. People long for the past.
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Mergers and Acquisitions Them and us continues.
Company led interventions Project managing the changes. Ensure hot button issues are addressed.
An integrated salary and benefit structure should be implemented as soon as possible
Creating a new unified company

Typical problems Internal issues have been resolved. The company is ready to look outwards. Lack of a focused strategy. Lack of direction. Need to build a new culture distinct from the past cultures of both companies. Need to build new brands.
Company or consultant led solutions Further teambuilding Values Strategic planning. Change management. Brand creation/management
Merger Behaviors
Given that a merger is never a transaction of equals and that it takes place within this context of uncertainty and emotional upheaval, the situation is ripe for regression into child hood roles. The accompanying child-like behaviour can generally be described under the following scenarios:
The stronger party at executive level

In this scenario, executives in the stronger company tend to see the merger as a new toy that everyone wishes to play with, which can result in miscommunication and the
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Mergers and Acquisitions dereliction of normal duties. Wanting to prove how well they can manage the merger, a power struggle between executives can emerge. To compound factors, they often fail to delegate and become overwhelmed with details. The lag in the decision-making process
leads to further uncertainty amongst staff and to a situation where decisions are not made consistently but in crisis mode.
The stronger party at staff level

Arrogance bred of a 'we are the best' mentality combined with an insecurity (even the stronger party feels betrayed by their leadership team) combine to create an atmosphere of locker room taunting, alienating the new partners in the merger. Also, the stronger partys usual pattern of conducting business becomes the norm. As a result, the best staff in the weaker organisation leave, since they are quite capable of finding employment elsewhere. The core of skills that was originally part of the reason to merge - not to mention a large part of the value of the company - is thus irretrievably lost.
The weaker party at executive level

Generally, these players don't want to play according to the new rules and leave. The loss of the guardians of the old culture leads to further demoralisation among staff. Where they remain, much of their energy is spent in undermining the way things were done in the original winning entity, rather than on building a new integrated entity.
The weaker party at staff level

At this level, people either refuse to play through a show of passive resistance, or try to spoil the pitch for the stronger party by hoarding information, thus making themselves indispensable. They view the pre-merger days as being perfect and the previous culture being ideal. As a result, they tend to pull together and resist any form of change.
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Due Diligence
Due diligence is a vital ingredient of mergers and acquisitions deals and is generally used for validating underlying assumptions. A comprehensive due diligence helps to uncover the underlying reality of historical data, turn the spotlight on negotiating issues, identify potential deal-breakers and generate a clear opinion on the target companys status and prospects. To put it simply the objective of due diligence is to assess the benefits and problems of the proposed mergers and acquisitions by inquiring into all relevant aspect of the past, present and future of the business to be acquired or merged with. It is not a pure financial audit although financial aspects form a part of the process. The due diligence investigation is much broader than an audit. The investigation places great importance on projecting how well the two organizations will function together operationally, in addition to projecting the anticipated financial benefits.
Types of Due Diligence:

Business due diligence:
The business due diligence is undertaken to assess the commercial feasibility and synergy between the organizations ( acquirer and target). The review normally involves assessment of targets business potential by evaluating brand strength, distribution system, market share, profitability and other economic considerations.
Technical due diligence:

The objective of technical due diligence is: To assess the plant capabilities in terms of its productivity, technology and equipment life.
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Mergers and Acquisitions Technical review is normally undertaken at the pre MOU stage except where the acquisition offer is from a close competitor or the target possesses product/process patents. These reviews are often carried out in-house except in the case where an independent valuation is required.
Human Resource due diligence:

One of the key components in any acquisition is the people associated with the target company, and their relationships, expertise, leadership quality and ability to manage the surviving entity. It is important to: Assess their qualifications, The likelihood they will remain with the merged company.
To achieve these objectives a human resource due diligence is undertaken. The human resource review provides both, qualitative and quantitative, outcomes. While the qualitative results are in terms of assessment of resource requirement and capabilities, the quantitative results are more in terms of ascertaining the liability towards "Go parachute" and "Golden hand shake" which influence the ultimate value of the potential acquisition. This review is generally undertaken only for strategic investment and is carried out in-house or by HR consultants.
Legal due diligence:

Legal due diligence is undertaken, with the following objectives To assess the impact of likely results of current and potentially pending litigation and result of recently concluded litigation, To ensure that the target company has complied with provisions of all the relevant statutes and there would be no potential liability on account of noncompliance, To assess the current and anticipated future impact of government regulations on the entity's cost level, and
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Mergers and Acquisitions To analyse the diligence is a post MOU event and is one of the important determinants of the value of the acquisition. Generally, the services of an independent agency is used carrying out a legal due diligence. However the reviewing team should comprise of at least one commercial person as detailed understanding of commercial aspects of the business is essential for analysing the impact of regulations on the cost level.
Environmental due diligence:

Organization of all kinds are increasingly concerned to achieve and demonstrate sound environmental performance by controlling the impact of their activities, product or services on the environment, taking into account their environmental policy and objectives. They do so in the context of increasingly stringent legislation, the development of economic policies and other measures to foster environmental protection, a growing concern from interested parties about environmental matters including sustainable development. Considering its increasing importance, many organizations at the time of acquisition have undertaken environmental reviews or audits to assess their environmental performance. The objective is: To obtain assurance that the environmental performance of the organization meets and will continue to meet its legal requirements. This review is generally undertaken only for strategic investments and is carried out by the in-house or external agencies.
Systems due diligence:

System due diligence is undertaken to ensure the proper management and adequate security of the data/information systems. The process involves: Review of IT security policy and procedures, Inter and intra location network review, Review of software applications and operating systems, and
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Mergers and Acquisitions Review of disaster recovery and business continuity plans.
System review is important both in the case of financial and strategic investment. However, in India such review is undertaken only for strategic investment purposes and at a post MOU stage.
The result of the due diligence has got a direct bearing on determining the value and viability of the acquisition/investment. The report normally outlines the current status of IT adopted, its scope, investment required for improvement and post investment/acquisition action plan. The investment requirement is determined after considering the desired return on IT investment. The review is normally undertaken by system auditors. The IT consultants, because of their vested interest, are not engaged for this purpose.
Tax due diligence:

The analysis of various taxes is one of the most complex areas that is encountered during an investigation. It is recommended that a tax expert, highly qualified in the entity's industry, be retained in the investigation team. The objectives of a tax due diligence are To analyze the impact of unpaid taxes/contingent liability against the target, To assess the impact of likely results of current and potentially pending litigation and result of recently concluded litigation, To assess the liability towards deferred taxes, and To analyze the future tax implications in respect of the potential acquisition.
Tax due diligence is also a post MOU event and is one of the determinants of the value of the acquisition. In the restructuring and mergers of companies under same group tax consideration is one of the "make or break" issues.
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Financial due diligence:

Financial due diligence is the most important part of the investigation exercise and is undertaken for all sorts of investment propositions, viz., financial and strategic investment, restructuring, lending and public offerings. The outcome of financial due diligence directly influences the value of the acquisition. It is observed that more than 600% of the revision in value from the first negotiated price is on account of the outcome of financial due diligence.
Generally, the objective of the financial due diligence is to establish the veracity of disclosed financial statements. However, review of internal control in terms of its effectiveness and adequacy, is an additional objective in the course of financial investment. The process of establishing the veracity of disclosed financial generally involves Establishing fairness of accounting policies adopted, Identification of off balance sheet items, and Establishing authenticity of the disclosed financial figures.
Since the final value is determined on the basis of adjusted financial statements, which incorporate quantifiable issues of all the due diligence, an effective coordination between a team of financial due diligence and other due diligences is a must.
Due Diligence in stages.

Due diligence is needed at various stages of the mergers and acquisitions deal. Whether it is evaluating a deal, executing a deal or harvesting a deal.
Evaluating a deal
A no-access due diligence is generally carried out at the deal evaluation stage itself. This primarily consists of desktop reviews. It involves combining financial analysis with market intelligence that can be gathered without access to the target company.
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Mergers and Acquisitions Such an evaluation is indispensable at the early stage of any mergers and acquisitions deal. This has to be done in a discreet and efficient manner. Few companies want their employees or public to know that they are undergoing acquisition discussions. Before a specific target is identified, a generic programme should be developed that specifies the business purpose of the acquisition programme and critical goals and objectives of the acquisition. Also it is important to bring in the right people at this stage. Few firms have all the resources needed to evaluate a potential target. Therefore in a typical due diligence
team, there are representatives from the acquirer, external legal counsel, public accountants and other required specialists.
Executing a deal
At the execution stage of the mergers and acquisitions deal a detailed due diligence is carried out. The deliverables include a detailed report on the negotiating points and areas to be protected in the acquisition agreement.
Harvesting a deal
This is a sell-side due diligence. Such a review covers a rounded view of the business, encompassing its performance and prospects and all issues that may be relevant to the acquirer. The objective of such a review is to uncover the deal issues and ensure that these issues are controlled by and dealt with by the seller, rather than being used as negotiating points by the acquirer. Put differently, harvesting a deal means doing due diligence on the assumption that buyers are waiting out there. It is doing due diligence at the sellers end. It involves assuming the existence of a buyer, foreseeing his problems and expectations and doing a SWOT analysis before a sell-off. Such a due- diligence by the seller maybe acceptable to the buyer at times.
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Communication
Most promoters forget that for a merger to succeed, a set of core and congruent messages must be crafted to create an understanding and win over the support and cooperation of all the stakeholders. If you ask a senior executive of a company what they want to achieve through mergers and acquisitions and they will tell you high rate of return for shareholders. Most of the time boardroom discussions center on whether a specific mergers and acquisitions will affect the stock price positively or negatively. During a merger most of the communication is focused on the so-called big guys analysts, investment bankers, lawyers, majority shareholders, regulators and the media to try and garner support for achieving the highest value for stocks. As a result, employees and minority shareholders, and occasionally the suppliers and the customers of the company are ignored. A clear employee communication strategy before, during and after the merger is as important as the need for clear vision and due diligence. Today every employee knows that mergers tend to mean job losses. As a result, as soon as the announcement is out, the most marketable among them lose no time in sending out their resumes. Unless employees are told that the deal will give them opportunities, they will be gone, often taking a big chunk of shareholder value with them even before the merger is complete. Companies also tend to forget their customers, he needs to feel that the merger will bring some value for him. Customers generally ask three types of questions : does the merger/ takeover mean that the company will be able to offer better products and services at better price? Does it mean better customer service? And will it help ensure stability to the company? Organizations that communicate with their customers should be very careful while listing customer benefits. They should be realistic and honest in
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Mergers and Acquisitions their communication. If there is any potential for disruption in product/service supply during the merger period, the customers should be informed. Several studies point out that communication is one of the success factors for any merger. It has to be substantive, comprehensive, planned and sustained. The best practices followed by the organizations that have succeeded with their mergers or acquisitions, consistently give importance to a comprehensive communication strategy.
Synergy
When most people talk about mergers and acquisitions they talk about synergy. But what is synergy? Synergy is derived from a Greek word synergos, which means working together, synergy refers to the ability of two or more units or companies to generate greater value working together than they could working apart. Typically synergy is thought to yield gains to the acquiring firm through two sources : Improved operating efficiency based on economies of scale or scope Sharing of one or more skills.
For managers synergy is when the combined firm creates more value than the independent entity. But for shareholders synergy is when they acquire gains that they could not obtain through their own portfolio diversification decisions. However this is difficult to achieve since shareholders can diversify their ownership positions more cheaply. For both the companies and individual shareholders the value of synergy must be examined in relation to value that could be created through other strategic options like alliances etc. Synergy is difficult to achieve, even in the relatively unusual instance that the company does not pay a premium. However, when a premium is paid the challenge is more significant. The reason for this is that the payment of premium requires the creation of greater synergy to generate economic value.
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Mergers and Acquisitions The actual creation of synergy is an outcome that is expected from the managers work. Achieving this outcome demands effective integration of combined units assets, operations and personnel. History shows that at the very least , creating synergy requires a great deal of work on the part of the managers at the corporate and business levels. The activities that create synergy include: Combining similar processes Co-ordinating business units that share common resources
Centralizing support activities that apply to multiple units Resolving conflict among business units
The types of synergy are:
Operations synergy: This is obtained through integrating

functional activities. It can be created through economies of scale / or scope.
Technology synergies: To create synergies through this , firms

seek to link activities associated with research and development processes. The sharing of R&D programs, the transfer of technologies across units, products and programs , and the development of new core business through access to private innovative capabilities are examples of activities of firms trying to create synergies
Marketing based synergies: Synergy is created when the

firm successfully links various marketing-related activities including those related to sharing of brand names as well as distribution channels and advertising and promotion campaigns.
Management Synergies: These synergies are typically gained

when competitively relevant skills that were possessed by managers in the formerly independent companies or business units can be transferred successfully between units within the newly formed firm.
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Private Synergy: This can be created when the acquiring firm has
knowledge about the complementary nature of its resources with those of the target firm that is not known to others.
Revenues
Revenue deserves more attention in mergers; indeed, a failure to focus on this important factor may explain why so many mergers dont pay off. Too many companies lose their revenue momentum as they concentrate on cost synergies or fail to focus on post merger growth in a systematic manner. Yet in the end, halted growth hurts the market performance of a company far more than does a failure to nail costs. The belief that mergers drive revenue growth could be a myth. A study of 160 companies shows that measured against industry peers, only 36 percent of the targets maintained their revenue growth in the first quarter after the merger announcement. By the third quarter, only 11 percent had avoided a slowdown. It turned out that the targets continuing underperformance explained only half of the slowdown; unsettled customers and distracted staff explained the rest. Only 12 percent of these companies managed to accelerate their growth significantly over the next three years. In fact, most sloths remained sloths, while most solid performers slowed down. Overall, the acquirers managed organic growth rates that were four percentage points lower than those of their industry peers; 42 percent of the acquirers lost ground. Why should one worry so much about revenue growth in mergers? Because, ultimately, it is revenue that determines the outcome of a merger, not costs; whatever the mergers objectives, revenue actually hits the bottom line harder
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Mergers and Acquisitions As the exhibit shows, fluctuations in revenue can quickly outweigh fluctuations in planned cost savings. Given a 1 percent shortfall in revenue growth, a merger can stay on track to create value only if a company achieves cost savings that are 25 percent higher than those it had anticipated. Beating target revenue-growth rates by 2 to 3 percent can offset a 50 percent failure on costs.
Illustration 1 Furthermore, cost savings are hardly as sure as they appear: up to 40 percent of mergers fail to capture the identified cost synergies. The market penalizes this slippage hard: failing to meet an earnings target by only 5 percent can result in a 15 percent decline in share prices. The temptation is then to make excessively deep cuts or cuts in inappropriate places, thus depressing future earnings by taking out muscle, not just fat. Finally, companies that actively pursue growth in their mergers generate a positive dynamic that makes merger objectives, including cost cutting, easier to achieve. Out of the 160 cos studied only 12 percent achieved organic growth rates (from 1992 to 1999) that were significantly ahead of the organic growth rates of their peers, and only seven of those companies had total returns to shareholders that were better than the industry average. Before capturing the benefits of integration, such merger masters look after their existing customers and revenue. They also target and retain their revenuegenerating talentespecially the people who handle relations with customers.
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Mergers and Acquisitions Thus it can be noted that if revenue is not monitored properly and if one does not make an effort to maintain revenue it can result in significant losses to the company.
Post merger pricing

Post merger pricing is a subtle art requiring much detailed work, which perhaps explains its neglect. It doesnt mean simply raising prices across the board, a move consumers would resist and regulators forbid unless there were corresponding improvements in benefits to customers. On the contrary, merging companies should assess pricing from a number of angles. Do the prices of the merged company accurately reflect changes in benefits to its customers, for example? Do its discount rules make sense after the merger? Do premerger price structures make a good fit with changes in operations and distribution? What messages will a new price structure send to competitors? When should it be introduced? The goal of any companys pricing policy is to charge as much as customers will pay for the benefits conferred by its products, assuming that those benefits are distinguishable, in quality and therefore price, from those offered by competitors. Mergers can increase such benefits by improving the quality of products and services, by adding attributes and services to products, and by improving terms and conditions of ownership. Granted, these things may not happen, or not right away. Customer service and sales support may suffer until the sales forces and customer service facilities of the merging companies learn how to cooperate and how each others products work. But prices can be raised when the benefits and cost savings of the merger exceed those that the acquirer advertised as justification for it. In the mid-1990s, for example, Cross National Bank (all company names in this article are disguised) acquired many local and regional banks and integrated them into its
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Mergers and Acquisitions established operations, providing extra benefits to customers who chose not to leave. Among these benefits were access to the companys automatic-teller-machine network now one of the largest in the countryand the security offered by a larger, bettercapitalized organization. Cross National realized that it had an opportunity to
raise prices to a level appropriate to these improved benefits. As soon as the benefits were made available to the customers of an acquired bank, they were absorbed into Cross Nationals pricing program. This invariably improved the profitability of the acquired bank and had little impact on its sales volumes. A merged company can just as decisively destroy value by failing to align prices with enriched customer benefits. In the early 1990s, for instance, International Compressors acquired State Compressor, which sold the same type of product but with fewer design features and at a lower price. State also had a weak field service network and a less comprehensive warranty. To reduce the cost of servicing and administering the two product lines after the merger, International equipped its field service team to support States products and equalized the warranty terms and coverage of the two lines. It left the price of States compressors unchanged. Shortly afterward, States sales rocketed, to the surprise of Internationals management, which believed that the design limitations (and thus higher maintenance costs) of States compressors made them less of a bargain than Internationals, despite their lower price. In reality, the new availability of Internationals superior field service and more extensive warranty had removed the drawbacks of States product, which had now become a great value at the old price. The new price-to- benefit ratio of States products eroded the market share not only of International but also of its competitors, Micro-Comp and European. Both reacted by cutting prices. International felt compelled to follow suit to maintain its share. Over the next 12 months, industry price levels fell by 7 percent, and the profitability of the merged company dropped to roughly half that of its two constituent parts before the merger (illustration 2 ).
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Illustration 2
Uncovering accumulated discounts:

A companys price structure comprises not just its list prices but also all of the other factors, such as discounts, allowances, and bonuses, that account for the money the seller eventually receiveswhat is known as the "pocket price." Left uncontrolled, these less visible factors can easily mount up: just the "off-invoice" discounts (those that dont even appear on the invoice) commonly equal 15 percent or more of the recorded sales revenue of a company, particularly if it sells its products through distributors or retailers. Merging companies often have different price structures. The leaders of the merged entity need to understand what will happen if both structures remain in force after the merger. For example: When two industrial-components suppliers recently merged, for example, they initially thought they had little to gain from consolidating the terms and conditions they gave to distributors, since their pricing structures looked fairly similar. Closer examination, however, uncovered several small differences with a large combined impact. The minimum order size for waiving their restocking fees varied, as did their
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Mergers and Acquisitions discounts for cash paymentsboth companies had a minimum order policy but only one strictly enforced itand their charges for expediting orders had different conditions and levels. Thus the merger forced the combined company to answer the question, "Which discount structure is right?" The company assembled a task force to compare the two structures. The team determined how different terms for cash discounts affected each companys average days outstanding on receivables, the impact of strict adherence to minimum orders on ordering patterns and costs, and other relevant pieces of information. In response, the company consolidated its terms and conditions for discounts, achieving an improvement of almost 2 percent in return on sales. Many merging companies dont trouble to analyze each organizations discount structure in detail, because they dont understand how much they are giving away to customers in the form of accumulated discounts. Particular functions may manage their own discount programslogistics, for example, might give discounts on freight, while marketing gives them on cooperative advertisingso the aggregate cost of such programs remains obscure. In the worst case, the combined company may unwittingly and wastefully continue to apply elements of both its predecessors discount programs to all post merger sales. A merger between suppliers may have the perverse effect of granting discounts for larger volumes to customers that havent increased the size of their orders at all. Take the hypothetical case of two companies, Superior Inc. and Elite Co., that sell to the same retailer. Both offer a 2 percent volume bonus or reimbursement on annual purchases worth from $250,000 to $1 million as well as a 4 percent bonus on purchases that exceed $1 million. The retailer buys $950,000 worth of goods from Superior and $250,000 worth from Elite, earning a 2 percent discount from both. Superior then merges with Elite. The resulting company keeps its predecessors volume bonus thresholds. The retailer is now purchasing $1.2 million worth of goods from the merged company, entitling it to a 4 percent discountthat is, a windfall of $24,000without increasing its purchases. Of course, the retailer may interpret this as compensation for reduced competition between its suppliers. Nonetheless, the merged company
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Mergers and Acquisitions inadvertently destroys value by ignoring the effects of the merger on the scale of discounts available to its predecessors shared customers.
Fuelling post merger demand

By carefully analyzing the various discount structure options, the merged company can adopt a more performance-based Dealer Partnership program that encourages dealers to stock the full breadth of the companys expanded product line. The program could give rewards to dealers that purchased multiple brands and did a large percentage of their business with the merged companyrewards that smaller competitors with narrower product lines cannot offer.
Adopting better pricing practices

Two companies of similar size can generally realize large savings by eliminating duplicative functions after merging. But when a larger company merges with a smaller one, there is less duplication to eliminate and therefore little to gain in the way of additional scale economies. Such a merger of unequals can nonetheless provide a valuable chance to improve pricing practices, policies, and systems throughout the combined company. Say that the larger company takes a haphazard approach to pricing, offering discounts to long-standing customers merely because they are long-standing, while its smaller counterpart is skilled at coordinating all the factors affecting pocket prices. If the combined company adopts the smaller companys better practices, the whole enterprise benefits. But if the larger one assumes that its approach to pricing is bound to be better than that of its smaller acquisition, it diminishes the value of the merger. In one instance, a consumer durables company acquired a somewhat smaller company with complementary product lines. The smaller company was better at managing accountlevel pricing: it could measure the profitability of accounts, applied strict controls to discretionary discounts, and had feedback mechanisms that identified opportunities to adjust prices for individual accounts. But the combined company adopted the acquirers arcane yet lax system of managing account-level pricing. Meanwhile, the salespeople of the acquired company, released from their accustomed controls, began to grant larger discounts. Over time, the loss of its pricing processes and systems destroyed a good deal of value. The fevered atmosphere surrounding a
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Mergers and Acquisitions merger between companies of any size generally makes it easier than usual to change peoples behavior. Companies can take advantage of this environment to improve their internal pricing processes, including who decides when to give which bonuses and discounts, and who collects and analyzes account information from the consolidated companies.
Setting the intensity of competition

While the supply of and the demand for an industrys output generally set the ceiling and floor of price ranges, the competitive conduct of the companies within an industry has a big influence on where, within that range, prices actually fall. The conduct of an individual company is determined by its intentions in the market (would it rather increase market share than profits or vice versa, for example), its ability to realize those intentions, and its perception of its competitors intentions and abilities. When a merger occurs, it is not only the new company that reassesses its intentions and abilities; so do its competitors. Changes made by the merged company to its marketing strategy and pricing can alter the intensity of competition in the whole industry. Precisely that occurred in the consumer durables industry. The two market leaders Simmons and Jeffreyfought furiously for market share, often through destructive price wars. They poached each others prime accounts and angled, largely in vain, for exclusive arrangements with retailers. Because most retailers preferred to carry several competing brands, both companies usually had to give back, in the form of trade discounts, the price increases they had earlier imposed. Then Simmons was acquired by Jericho, which sold unrelated consumer products. Jeffreys president called for an analysis of the mergers likely impact on competition. The managers reported that Jericho focused on profits and rarely competed on price. On the basis of this information, Jeffrey announced that it would no longer seek exclusive relationships with retailers and would raise the profit margins of a number of its products by increasing prices 2.5 percent. Its sales planners decided to cease overtly courting key accounts "owned" by Simmons but due for renegotiation. Jeffreys take on the competition was right on target: Jericho followed Jeffreys price increases and stopped courting accounts "owned" by Jeffrey.
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Mergers and Acquisitions Through this one can see that post merger pricing affects the competitors as well.
Managing cultures
Basing a merger decision purely on financial criteria is similar to deciding that your inlaws must move in to help share the rent. It may make financial sense, but it certainly doesn't take into account the disruption or impact this will have on your family life.
What is culture?
Culture concerns the internalization of a set of values, feelings, attitudes, expectations and the mindsets of the people within an organization. This culture provides meaning, order and stability to their lives and influences their behavior. Organizational culture exists at two levels. 1. Those values that are shared by the people working in the organization, values that tend to persist within the organization even if its membership changes. 2. The behavior patterns or style of an organization. New employees are automatically encouraged to behave in a similar fashion by their colleagues. Culture can be categorized into various types such as Power Cultures, Support Cultures, Task \ Achievement Cultures and Role Cultures. The various aspects of culture can also be synthesized into a number of dimensions such as conflict resolution, culture management, customer orientation, and disposition towards change. Prior to a merger, the cultures of both organizations should be measured on these dimensions in order to determine the level of compatibility (or incompatibility) of the two organisations. Measuring and understanding the diverse organisational cultures should form part of the due diligence process, as it provides the negotiators from both parties with a sound understanding of the human resource issues. In this way, the cost of dealing with these issues can then be factored into the acquisition price of the company. Unless this is
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Mergers and Acquisitions done, an acquirer might, in many cases, find that they have bought less than they bargained for.
The other advantage of conducting an organisational culture audit before the companies are officially merged is that it provides a basis to measure later interventions to merge organisational culture. In addition, it focuses the energies of the executives in creating a unified organisation that maximises potential synergies. The tendency in mergers is to take the easy route and adopt the stronger culture; however, an opportunity to merge the best of both cultures is then missed. The earlier the direction of the new company and its identity is decided upon, as well as which parts of both contributing cultures are going to be kept, the easier the decision-making process will be, and the less the chance of losing a valuable aspect from either culture. The merger of two culturally different organizations could result in conflict during the period immediately following the merger or acquisition. This often results in a decrease in employee morale, anger, anxiety, communication problems and a feeling of uncertainty about the future. The organisation that does not take the positive aspects of organisational culture and the human resources within the acquired company into account, is missing one of the most valuable assets of that organisation: Intellectual capital. Executives who fail to consider these issues when acquiring a company are not serving themselves or their shareholders. An example of a merger that failed due to improper integration or understanding of cultures is the Daimler-Benz and Chrysler merger. People said that even seemingly mundane communication differences between the employees of the German and the American auto giants challenged the stability of the combined entity. The basic differences in the merger started cropping up because their, mentalities were opposite. Americans were bothered only with the vision and they would fill in the details in later. Germans are trained to think deductively and they kept thinking how they would make it work. Even something as innocuous as the office-seating layout started straining the
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Mergers and Acquisitions relations. The Germans kept the doors of their office cabins closed because thats how they are trained but Americans always thought that the Germans were having meetings excluding them. The formal Germans and the informal Americans had a tough time trusting each other.
People in mergers
An announcement of a merger or an acquisition sends a strong a message to your competitors and to the recruiting firms that serve them: your employees are ripe for the picking. Competitors understand that your employees dont know whether they have a job or, if they do, where it will be located, where they fit into the new companys structure, how much pay they will receive, or how their performance will be measured. Key employees usually receive inquiries within five days of a merger announcement precisely when uncertainty is at its highest. And no organizational level is exempt. Plenty of attention is paid to the legal, financial, and operational elements of mergers and acquisitions. But executives who have been through the merger process now recognize that in todays economy, the management of the human side of change is the real key to maximizing the value of a deal. Indeed, a recent survey determined that more than three-quarters of top executives at 190 companies in Brazil, China, Hong Kong, the Philippines, Singapore, South Korea, and the United States believe that retaining key talent is a "critical" ingredient of M&A integration. ( Illustration 3)
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Illustration 3
Identifying and keeping key employees.

Your first challenge results from the fact that before even the most efficient process is complete, employees will become anxious, some intensely so. Therefore, it is best if key employees learn about their prospects well before the process endsideally, before the deal is announced. The first step should be a "top-to-top" meeting at which a few of the most senior officers from both companies quickly develop a list of 50 to 100 employees indispensable to the new organization, recognizing that the need for haste means that some choices will be based on limited insight. One person should then be charged with managing the business of keeping key employees on board; otherwise, this essential activity usually falls victim to the overwhelming task of integration. At the same time, line managers close to the level in question should make the actual selections. A simple matrix can help identify all key employees. You can keep track of what would motivate them not to jump ship, what actions you will take to keep them (and when), and who should be directly responsible for assuring that they stay. We call this a "re-recruiting matrix" because if you put as much energy into keeping people as you had earlier put into recruiting them, you will succeed.
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Illustration 4
Importance of communication with the employees

Executives often feel uncomfortable communicating with key employees after a merger because so many of their questions cant be answered. But not meeting with key employees can be fatal. During a recent global pharmaceutical merger, a key employee confessed that before the offer of an attractive position in the new organization came, she had been interviewing for a job with another company. The merger was the most important event on her employers agenda, but she had not been involved, nor had anyone brought her up-to-date. Ignorant of where she stood in the new organization, she did not assume that something worthwhile would come along. It was sheer luck that she had not yet accepted another job. Key employees who are made to feel part of the process, allowed to make a case for their candidacies, and reassured that their company of origin wont be counted against them are less likely to fall through the cracks. If key employees dont feel that they are in the loop, they will probably be busy looking for career opportunities elsewhere.
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Retaining staff through incentives

Of course, attractive incentives can maintain performance and retain key staff; the trick is to pay neither too much nor too little. Generally, retention incentives add 5 to 10 percent to the total cost of a dealenough to wreck itand it is therefore vital to anticipate them. The most important factor to consider when you are trying to retain and motivate people is how much "walk-away" money they receive from the merger. For employees without stock, and therefore without the wherewithal to walk away easily, amounts equal to 50 percent of three, six, or nine months of salary (depending upon how valuable they are) should be sufficient. Sometimes staggered payments at those intervals can provide the best solution. More senior employees with stock may need 100 percent of salary, plus a bonus. Top executives who have done very well in the merger may require 100 percent of direct compensationthat is, salary and bonusplus the value of their stock option grant for that year. In the case of senior employees with a great deal of walk-away money, it helps to provide half of their bonus in cash and half in stock options, so that they are motivated to stay and help make the integration effort successful. Incentives can be staggered over time. When one health care supply firm acquired another, creating a $20 billion (revenue) organization, the acquired company was facing bankruptcy. The deal was completed in one month. All senior managers of the acquired company were fired on the first day except for two people with important knowledge. These two were given incentive packages that expired after 18 months, along with their employment. The total package for each of them amounted to between $3 million and $4 million. The payouts were staged and required the two executives to meet a series of targets involving the reduction of costs and head counts, the retention of key employees, and the quality of customer service. Even so, half of the money was held back until the last
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payment. By that point, the measures taken had reduced costs by 80 percent without making much of a dent in revenues. Another company gave managers of a retail acquisition, also in bankruptcy, bonuses of 20 to 50 percent of their base salary, accruing monthly over six months to a year, depending on their level. In a second retail merger, integration teams received bonuses drawn from a pool that emptied as targets were met. Long integration periods, for which regulatory scrutiny is typically responsible, make retaining key staff especially difficult. In these situations, either particular individuals or some portion of a particular target group may require added incentives, along with explicit assurances of their future roles and job security over a certain period. During such efforts, it is particularly important to keep the entire staff fully updatednot least, parent-company employees whose positions overlap those of people in the acquired company. Once everything has been done to promote the retention of key employees, attention must shift to the way terminations are handled. The best long-term strategy is a very generous severance plan: the cost is high, but good plans have a strongly positive influence on the morale of the remaining employees. In a merger between two regional utilities, for example, only some of the nowunwanted executives of the acquired company had golden parachutes triggered by a change of control. To encourage many more to jump, the acquiring company gave them severance packages, while those executives who were asked to stay received generous cash and stock bonuses. Thanks to this policy, the remaining employees and executives felt they would be treated fairly in the future.
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Staffing decisions in Mergers and Acquisitions

In M&A, there are basically four choices: operational independence, a takeover of one company by another, a merger of equals, and what might be called a transformational approach, in which the two merging companies change into something much stronger than either of them had been before. When companies decide on operational independence, there are few choices to make. Since most people will stay in place, the imperative is to clarify the roles of only the most senior executives. The takeover approach usually proceeds on the assumption that the acquirers management will remain, though exceptions may be made when the acquired companys employees are clearly superior. One Fortune 500 chemical company, for example, merged with another chemical company that had a weaker management team. This was clearly a takeover, but the acquirer recognized that in a few areas, the other company was better managed. So the acquirer quickly identified the acquirees key people, told them that they were well regarded, and offered incentives sufficiently generous to keep them. For the most part, however, stabilizing the acquired company takes priority over a protracted and exhaustive evaluation of every employee. It is the third and fourth organizational approaches that represent the real challenge. A merger of equals requires a "best of both" solution, in which employees of the two organizations are evaluated for each executive position. That is true even in the transformational approach, which calls for what might be described as the "best of both plus. These kinds of processes cannot be worked through overnight, and that leaves many important employees vulnerable to outside offers during the period of uncertainty employees you may not even have time to identify! To keep good people, the evaluation and selection process must proceed as quickly as possible. Experience suggests that six to eight weeks will generally suffice to staff each level of the organization. By getting a
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Competition
Companies can time strategic attacks against their competitors precisely when those firms are most vulnerable- when they are floundering in the chaos of merger and acquisition integration. Integration can be so disruptive that combining firms lose at least part of their external vision because they are forced to focus inward on their immediate acquisition or merger integration problems. One classic example of this is Coca-Colas acquisition and troubled management of Columbia pictures corporation which gave Pepsicos Choice of a New Generation marketing campaign just the boost that it needed to be a huge success. Coke struggling to find its way in the Columbia Pictures acquisition integration saw its own legendary marketing organization flounder in response to Pepsis bold advertising staring pop-star Michael Jackson. Its response was to replace its traditional coca-cola with New Coke- which quickly became one of the biggest marketing fiascos of the century. The public didnt like the New Coke and refused to buy it. The firm finally sold of their disastrous Columbia pictures acquisition and re-instated Classic Coke, 3 months later. Pepsi stole market share by attacking coke at its most vulnerable and outsold coke for the very first time ever. Even for top shelf companies like Coke, the impact of absorbing an acquisition can be devastating. For decades, banks, computer and automotive manufacturers, and other firms have launched aggressive new product or service introductions and marketing campaigns much more successfully when they were timed to co-incide with their direct competitors merger distractions. A company in the midst of a merger simply does not have the same ability to launch counter measures while they are busy integrating staffs and operations. A poorly managed merger integration heaps so much extra work on managers that the company is simply unable to respond to attacks against its market share. In case the company is a supplier, the customers know that uninterrupted and on time delivery can be in serious jeopardy. A business that lives or dies by the reliability of its vendors will listen to proposals from alternative suppliers, in other words the merging companies competitors.
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Valuation
Valuation of the target firm is extremely important in a merger or an acquisition deal. There are a few methods that have been explained here. However practically discounted cash flow method and trading multiples of peer firms are most commonly used.
Discounted Cash Flow method (DCF)

The discounted cash flow approach in an M&A setting attempts to determine the value of the company (or enterprise) by computing the present value of cash flows over the life of the company. Since a corporation is assumed to have infinite life, the analysis is broken into two parts: a forecast period and a terminal value. In the forecast period, explicit forecasts of free cash flow must be developed that incorporate the economic benefits and costs of the transaction. Ideally, the forecast period should equate with the interval in which the firm enjoys a competitive advantage (i.e., the circumstances where expected returns exceed required returns.) or till a firm achieves stable growth and stable capital structure. For most circumstances a forecast period of five or ten years is used. The value of the company derived from free cash flows arising after the forecast period is captured by a terminal value. Terminal value is estimated in the last year of the forecast period and capitalizes the present value of all future cash flows beyond the forecast period. The terminal region cash flows are projected under a steady state assumption that the firm enjoys no opportunities for abnormal growth or that expected returns equal required returns in this interval. Once a schedule of free cash flows is developed for the enterprise, the Weighted Average Cost of Capital (WACC) is used to discount them to determine the present value, which equals the estimate of company or enterprise value.
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Free cash flows

The free cash flows in an M&A analysis should be the operating cash flows attributable to the acquisition, before consideration of financing charges (i.e., pre-financing cash flows). Free cash flow equals the sum of after-tax earnings, plus depreciation and noncash charges, less capital investment and less investment in working capital. From an enterprise valuation standpoint, earnings must be the earnings after taxes available to all providers of capital or NOPAT (net operating profits after taxes.) The expression for free cash flow is: Free Cash Flow = EBIT (1- T) + Depreciation CAPEX - NWC, where: EBIT is earnings before interest and taxes. T is the marginal cash (not average) tax rate, which should be inclusive of federal, state and local, and foreign jurisdictional taxes. Depreciation is noncash operating charges including depreciation, depletion, and amortization recognized for tax purposes. CAPEX is capital expenditures for fixed assets. NWC is the change in net working capital.
Terminal value
A terminal value in the final year of the forecast period is added to reflect the present value of all cash flows occurring thereafter. Since it capitalizes the long-term growth prospects of the firm, terminal value is a large component of the value of a company, and therefore careful attention should be paid to it. A standard estimator of the terminal value in period t is the constant growth valuation formula.
FCF (1 + g) Terminal Value = (WACC g) , where:
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FCF is the expected free cash flow to all providers of capital in period t. WACC is the weighted average cost of capital. g is the expected constant growth rate in perpetuity per period.
Discount rate
The discount rate should reflect investors opportunity cost on comparable investments. The WACC must reflect the capital costs that investors would demand in owning assets of similar business risk to the assets being valued. In addition, because the WACC also imbeds an assumption about the target mix of debt and equity, it also must incorporate the appropriate target weights of financing goingforward. Recall that the appropriate rate is a blend of the required rates of return on debt and equity, weighted by the proportion these capital sources make up of the firms market value. WACC = W k (1-T) + W k , where: d d e e k is the interest rate on new debt. d k is the cost of equity capital . e W , W are target percentages of debt and equity (using market values of debt d e and equity.) T is the marginal tax rate.
To understand this method better let us take an example:
Example of DCF Method

Suppose A-Company has learned that its competitor, B-Company, has retained an investment bank to auction the company and all of its assets. In considering how much to bid for B-Co., A-Co. starts with the projected cash flow statement drawn up by BCo.s investment bankers shown below. If a competitor or A-Co. were to acquire B-Co. and allow it to run as an autonomous, or stand-alone unit it would also make sense to use B-Co.s weighted average cost of capital of 10.94% to value the company. The inputs to WACC will be discussed further later.
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On a stand-alone basis, the analysis suggests that B-Co.s enterprise value is $13.7 million. Cash Flows of B-Company with No Synergies (Assume that A-Company or other acquirer allows former B-Company to run as a stand-alone unit.) Revenue Growth 3% Terminal Value Growth 3% COGS 55% WACC 10.94% SG&A 20% Tax rate 39% NWC 22%
Year 0 Revenues ($thousands) COGS Gross Profit SG& A Depreciation Operating Profit (pre-tax) Taxes NOPAT Add: depreciation Less: Capital Expenditures Less: Increase in NWC Free Cash Flow 9,750
Year 1 Year 2 Year 3 Year 4 Year 5 10,00 10,30 10,60 10,92 11,25 0 5,500 4,500 2,000 1,000 1,500 585 915 1,000 (800) (55) 1,060 0 5,665 4,635 2,060 1,000 1,575 614 961 1,000 (800) (66) 1,095 9 5,835 4,774 2,122 1,000 1,652 644 1,008 1,000 (800) (68) 1,140 7 6,010 4,917 2,185 1,000 1,732 675 1,056 1,000 (800) (70) 1,186 5 6,190 5,065 2,251 1,000 1,814 707 1,106 1,000 (800) (72) 1,234
Illustration 5
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Valuation of B-Company with No Synergies Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Free Cash Flow Terminal Value Total Cash Flows 1,060 1,095 1,140 1,186 1,060 1,095 1,140 1,186 1,234 16,00 8 17,24 3
Illustration 6 Enterprise value = 13,723 ( after discounting at a WACC of 10.94%) Now suppose A-Co. believes that it can make B-Co.s operations more efficient and improve its marketing and distribution capabilities. We can incorporate these effects into the cash flow model, and thereby estimate a higher range of values that A-Co. can bid and still realize a positive net present value (NPV) for A-Co.s shareholders. In the combined cash flow model of the two firms below, A+B-Co. has added two percentage points to revenue growth and subtracted one percentage point from both the COGS/Sales and SG&A/Sales ratios relative to the stand-alone model. We assume that all of the merger synergies will be realized within the first five years of combined operations and thus fall within the forecast period. Because A and B are in the same industry, it is assumed that the business risk of B-Co.s post-merger operations are similar to A-Co.s. Because the two entities have the same business risk and A-Co. is the purchaser and surviving entity, we can use A-Co.s WACC of 10.62% in the valuation. Notice that the value with synergies, $14.6 million, exceeds the value as a stand-alone entity by approximately one million dollars. In devising its bidding strategy, A-Co. would not want to offer $14.6 million and concede all of the value of the synergies to B-Co. At this price, the NPV of the acquisition to A-Co. is zero. However, the existence of synergies allows A-Co. leeway to increase its bid above $13.7 million and enhance its chances of winning the auction. Combined Cash Flows of A+B-Co. with Synergies (Assume that former B-Co. operations are merged with A-Co. and have the same business risk.)
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Mergers and Acquisitions Revenue Growth 5% Terminal Value Growth 3% COGS 54% WACC 10.62% SG&A 19% Taxes 39% NWC 22% Year 0 Revenues ( $ thousands) COGS Gross Profit SG&A Depreciation Operating profit after tax Taxes NOPAT Add: Depreciation Less: Capital Expenditures Less: Increase in NWC Free Cash Flow 9,750 Year 1 10,000 5,400 4,600 1,900 1,050 1,650 644 1,007 1,050 (1,000 ) (55) 1,002 Year2 10,500 5,670 4,830 1,995 1,050 1,785 696 1,089 1,050 (1,000 ) (110) 1,029 Year3 11,025 5,954 5,072 2,095 1,050 1,927 751 1,175 1,050 (1,000 ) (116) 1,110 Year 4 11,576 6,251 5,325 2,199 1,050 2,076 809 1,266 1,050 (1,000 ) (121) 1,195 Year 5 12,155 6,564 5,591 2,309 1,050 2,232 870 1,361 1,050 (1,000 ) (127) 1,284
Illustration 7 Valuation of A+B-Co. with Synergies Year 0 Year 1 Year 2 Year 3 Year4 Year 5 Free Cash Flow Terminal Value Total Cash Flows 1,002 1,029 1,110 1,195 1,002 1,029 1,110 1,195 1,284 17,35 7 18,64 1 Illustration 8 Enterprise Value = 14,618 ( after discounting at WACC of 10.62%)
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Book value
May be appropriate for firms with no intangible assets, commodity-type assets valued at market, and stable operations.
Some caveats:
This method depends on accounting practices that vary across firms. Ignores intangible assets like brand names, patents, technical know-how, managerial competence. Ignores price appreciation due, for instance, to inflation. Invites disputes about types of liabilities. For instance, are deferred taxes equity or debt? Book value method is backward looking. It ignores the positive or negative operating prospects of the firm.
Liquidation value
The sale of assets at a point in time. May be appropriate for firms in financial distress, or more generally, for firms whose operating prospects are very cloudy. Requires the skills of a business mortician rather than an operating manager.
Some caveats:
Difficult to get a consensus valuation. Liquidation values tend to be highly appraiser-specific. Key judgment: How finely one might break up the company: Group? Division? Product line? Region? Plant? Machines? Physical condition, not age, will affect values. There can be no substitute for an on-site assessment of a companys real assets. May ignore valuable intangible assets.
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Stock-market value (stock price shares outstanding)

Helpful if the stock is actively traded, followed by professional securities analysts, and if the market efficiently impounds all public information about the company and its industry. Rarely do merger negotiations settle at a price below the market price of the target. On average, mergers and tender offers command a 30-50% premium over the price one day before the merger announcement. Premiums have been observed to be as high as100% in some instances. Often the price increase is attributed to a control premium. The premium will depend on: i. the rarity of the assets sought after and to what extent there are close substitutes for the technology, expertise, or capability in question, ii. the distribution of financial resources between the bidder and target, iii. the egos of the CEOs involved (the hubris hypothesis), or iv. the possibility that the ex ante target price was unduly inflated by market rumors. Less helpful for less well-known companies with thinly or intermittently traded stock. Not available for privately-held companies. Ignores private information known only to insiders or acquirers who may see a special economic opportunity in the target company. Remember, the market can efficiently impound only public information.
Trading multiples of peer firms

Most frequently observed are price-earnings ratios and market value of equity to book value of equity ratios. If a multiple is used in place of the constant growth model for terminal value, the multiple must be based on cash flow, EBIT, or EBITDA (i.e., not PriceEarnings ratio). Only these multiples are consistent with the definition of free cash flow as pre-financing cash flows available to all capital. Requires a forecast of EBIT or earnings for the next year. Never use last years EBIT or earnings; the market only capitalizes future performance. Requires careful research to find other firms comparable to the target company.
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Depends on accounting practices. There are a number of acceptable ways to determine operating earnings. Assumes the same (but undefined) growth rate in perpetuity. Can ignore the critical differences between profits and cash flow: e.g., new capital expenditures and investment in net working capital, and depreciation.
May not separate the investment and financing effects into discrete variables. Difficult to analyze the effect of financing changes. May ignore the time value of money.
Transaction multiples for comparable deals

In an M&A setting, analysts will look to comparable transactions as an additional benchmark against which to assess the target firm. The chief difference between transaction multiples and peer multiples is that the former will reflect a control premium, typically 30 to 50 percent, that is not present in the ordinary trading multiples. If one is examining the price paid for the target equity, transactions multiples might include the offer price per share target book value of equity per share, or offer price per share target earnings per share. If one is examining the total consideration paid in recent deals, one can use Enterprise Value EBIT. The more similarly situated the target and the more recent the deal, the better the comparison will be. Ideally, there must be several similar deals in the last year or two from which to calculate median and average transaction multiples. If so, you can glean valuable information about how the market has valued assets of this type. Analysts will also look at premiums for comparable transactions by comparing the offer
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Mergers and Acquisitions price to the targets price before the merger announcement at selected dates, such as one or 30 days, before the announcement. A negotiator might point to premiums in previous deals for similarly situated sellers and demand that shareholders receive what
the market is paying. One must look closely, however, at the details of each transaction before agreeing with this premise. How much the target share price will move upon the announcement of a takeover will depend on what the market had anticipated before the announcement. If the share price of the target had been driven up in the days or weeks before the announcement on rumors that a deal was forthcoming, the control premium may appear low. To adjust for the anticipation, one must examine the premium at some point before the market learns of (or begins to anticipate the announcement of) the deal. It could be also that the buyer and seller in previous deals are not in similar situations compared to the current deal. For example, some of the acquirers may have been financial buyers (leveraged buyout (LBO) or private equity firms) while others in the sample were strategic buyers (companies expanding in the same industry as the target.) Depending on the synergies involved, the premiums need not be the same for strategic and financial buyers. There are many more methods of valuation that can be adopted and used however I have limited my study to the already mentioned methods
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Success of Mergers and Acquisitions

Even with thoughtful planning and preparation, best practices, focus and looking at all the issues involved in a merger or an acquisition transaction success is not guaranteed. However, applying the best practices should enhance the chances of success and help avoid catastrophic pitfalls.
Correlations to success
Are there key variables that serve as indicators or predictors of a deal's success? There are dozens of correlations. But I have discussed three variables: the purchase premium paid by the acquirer; the relative size of the acquirer and the acquiree, and the overlap (or lack thereof) in the businesses in which the acquirer and acquiree compete.
Illustration 9
1. Correlation of Purchase Premiums. The purchase premium

paid is not correlated to the deal's success. (Illustration 9 ).In other words, companies
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Mergers and Acquisitions that paid very high premiums do no worse than companies that paid small premiums, or in some cases, no premiums at all. The reason is that companies that are successful in mergers and acquisitions are able to create value an order of magnitude greater than the purchase premium they paid. An example: In May 1995, the Williams Companies paid a 307 percent premium for the Transco Energy Company, creating the nation's largest volume natural gas pipeline system. Transco is the largest of the five interstate pipeline systems owned by Williams. While analysts were cool to the deal, Williams saw the real value in investing in Transco's equipment and having access to the valuable Eastern United States market. Wall Street immediately took more than $250 million - more than 10 percent - off Williams' market value, leaving the stock at $25 a share, 25 percent below its 1994 high when the deal was announced (in late 1994). Meanwhile, Transco had been struggling under a heavy debt load that was incurred in settling poorly priced gas contracts in the mid-1980's. Williams had capital to invest, having just sold its Wiltel Network Services unit to LDDS Communications (now known as MCI Worldcom) for about $1.6 billion after tax. Williams' strategic vision, coupled with its ability to manage the significant change inherent in a merger, enabled the Williams/Transco entity to outperform industry peers by 62 percent and create more than $4.7 billion in additional value.
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2. A Question of Relative Size. Another factor is the relative size of

the acquirer and target company. A study compared the acquirer to the target in terms of market capitalization and sales, and the absolute size of the acquirer, to see if any excess returns existed. No excess returns were found. (See Illustration 10 )
Illustration 10
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3. Industry Similarity. A study examined whether excess returns were

derived from the type of merger created using several different methods. It was found that there were no excess returns for vertical (different industry) or horizontal (similar industry) mergers. For example, industry similarity between the two partners in the deal, as measured by similarity in primary SIC code, showed no significant correlation and very wide variances. (See Illustration 11) Some, such as USA Waste Services' acquisition of Western Waste Industries, were horizontal mergers driven by consolidation; that deal delivered 66 percent in excess return. Conversely, other companies used acquisitions in different but related industries to advance their strategies. An example is the Tosco Corporation's acquisition of the Circle K Corporation, which allowed Tosco to outperform peers by 65 percent. Circle K, now the marketing division of Tosco, is the largest operator of company-owned convenience stores in the United States.
Illustration 11
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Mergers and Acquisitions If these simple measures give no clues about why some companies do better than others, it becomes difficult to draw conclusions. In order to understand why certain companies are able to achieve higher returns, one needs to look behind the scenes to
study the details of what the companies did - beyond the simple measurements and into the complex texture of their merger and acquisition process. How can a company increase the odds of success? Research shows that the most successful companies link effective strategic formulation, pre-merger planning and post-merger integration. (See Illustration 12 .) Having all three components is critical for success: A vision, strategically formulated, for where the company is going and how the deal fits. Companies then identify the appropriate targets and get the deal done. A pre-merger process that targets companies with the right capabilities, gets the deal done and begins the integration through rigorous planning and building of trust among the players. A post-merger process that seeks to capture well-defined sources of value and is led in a way that captures as much value as possible as quickly as possible.
Illustration 12 However some mergers may not succeed even after taking into account all these factors.
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Why mergers and acquisitions are growing in India?

These are some of the reasons that mergers and acquisitions are growing in India
Easing of regulations: Economic liberalization and the recent crisis

(the Indonesian currency devaluation) have now speeded up deregulation. In India a country largely untouched by the financial problems that have hit other economies foreign companies are now allowed to acquire controlling stakes in publicly listed Indian companies (provided the owners give consent).
Restructuring of family owned conglomerates: In

India, seven of the top ten private companies are family owned, and the top 50 family-owned business groups account for 30 percent of total industry turnover. These businesses once thrived in a protected environment where political connections mattered more than business acumen. In India, which companies grew and which stagnated was largely determined by their relationships with government. The result has been markets dominated by networks of privileged companies, many of which could not have stood up to competition from overseas.
Liberalization has forced change. Increased competition,

reinforced by the arrival of multinationals, as well as by investors' and consumers' higher expectations, has made local companies consider shedding non-core businesses.
Sale of state-owned companies: in India the estimate of PSUs

making losses is 50%. Privatization is seen as a way of raising performance as well as government funds. In India, where privatization activity has been relatively limited, the government has sold minority stakes in some 40 companies, including Hindustan Petroleum and Bharat Earth Movers. The Indian government has said it
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Mergers and Acquisitions plans to raise at least another $2 billion in the next two years through further disinvestments.
Overcapacity: Booming demand from an increasingly affluent Indian

middle class attracted foreign investment of more than $300 billion into the region during the six years up to 1996. The 20 percent annual growth rate of this incoming capital outstripped GDP growth, and led to severe overcapacity in the car, steel, and chemicals industries. The current decline in the region's expansion can only make things worse. Excess capacity is likely to prompt struggling companies to consider selling out, and offer acquisitive companies a relatively cheap way to buy in.
Where the best value creation opportunities lie for the acquirers?
Improve operating performance Labor and capital productivity in
several Asian countries is far weaker than it is in the West. According to the World Competitiveness Yearbook, 1997, productivity in India is estimated to be as low as 5 percent of US levels. Poor operating performance is one of the main reasons, which means there are opportunities for companies with strong core operating capabilities that can buy poor performers, cut costs, improve processes, and raise product and service quality.
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Capture scale economies. Industries such as pharmaceuticals and

banking that could exploit scale economies have long failed to do so in several Asian markets. There is therefore tremendous potential for buyers to create value by acquiring small companies and consolidating manufacturing, distribution, and selling.
Restructure the industry. Lack of competition has enabled local

companies to thrive despite poor products and services. There are therefore opportunities for buyers to acquire these companies with the principal aim not of improving existing businesses or capturing synergies, but of building entirely new business models. Hindustan Lever, a subsidiary of Unilever, is changing the face of India's ice-cream market in this way. A few years ago, the market was the preserve of small regional icecream makers. After acquiring the three largest for $60 million, Hindustan Lever now boasts a market share of about 70 percent and is expanding its product range, investing heavily in advertising and promotion to build stronger brands, and improving refrigerated transportation and retail cold storage facilities to increase product shelf life and market penetration. What used to be a slow-growing, fragmented market is now expanding by more than 20 percent a year. Although Hindustan Lever will create some value by improving the acquired businesses and capturing scale economies, most will derive from the way the company is transforming the industry, creating a market for a higher-quality product and a broader product range, and boosting demand to new levels.
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Making India mergers and acquisitions friendly

Mergers and acquisitions are growing in India as stated above but yet there are a lot of obstacles in the way. These are some ways in which India can be made more merger friendly:
Financial Institutions (FIs) :
FIs are one big hurdle that is
preventing Indian mergers and acquisitions from getting turbocharged. These FIs have a difficult to change mindset and are impediments to wealth creation. They are irrational and continue to hold stakes in companies which bring in no returns. Quite often their decisions and actions have prevented industries from becoming competitive. For, their decision to sell corporate stakes are not driven by merits of the offer, but by what their political masters tell them to do. No doubt FIs have not allowed a lot of deals to go through. The Essar Power Marathon, the RIL- L & T deals are a few examples of how the Indian FIs act as spokes in the mergers and acquisitions wheel.
Steep Stamp Duties: Stamp duty is a state subject and thus varies from
state to state. By any , standard stamp duties are high in India : for instance, they are at a high of 21% in Bihar. In mergers where huge real estate is involved, stamp duty payable tends to be quite exorbitant. One solution to this could be to introduce a uniform stamp duty structure or to make stamp duty a central subject.
Torturous merger process: Court process needed to put through

mergers is another spoilsport in the Indian mergers and acquisitions scene. The merger process is torturously slow. And if the companies involved in the merger fall in two different legal jurisdictions it takes a much longer time. In order to solve this you can rationalize the merger process and achieve better coordination with the Registrar of Companies. Mergers should not need a court process, particularly if they are straight mergers involving share swaps.
Holes in the take over code: This poses a serious problem for Indian
mergers and acquisitions. For instance the code permits an acquirer to make a
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Mergers and Acquisitions minimum offer instead of making an offer to all the shareholders. If an acquirer crosses the 15% 8mark, he has to make a minimum offer to 20% of the shareholders. That means that by acquiring a 35% stake someone can take the whole company over. Thus the take over code needs to be reviewed.
Cash or shares: Should it continue to be mandatory for shareholders of the

target company to accept whatever the acquirer doles out? Giving cash or shares for an acquisition is left to the bidder. Once the bidder decides, the shareholders have to accept the bidders mode of payment. Investors have no choice. This area needs to be reformed.
Legal hurdles: Consolidation of accounts is another major issue. Even if the

acquired company becomes a 100 per cent subsidiary of the acquiring company, there is no provision allowing consolidation of holding company and subsidiary company accounts. That is why , say , Tata Tea will not be able to consolidate the accounts of Tetley with its own accounts. Such a situation prevents the acquirer from getting a better rating. Amending the definitions of mergers and demergers in the Indian Income Tax Act could also accelerate mergers and acquisitions activity in India.
Attitudinal changes: Accelerating the pace of mergers and acquisitions

also calls for drastic attitudinal changes among Indian business families, mergers and acquisitions intermediaries and corporate managers. Indian business families hardly know anything about share valuation. Concepts such as discounted cash flows and shareholder values are alien to them. The government needs to change its mindset. A huge part of the Indian enterprise still belongs to the government. So the government should divest lock, stock and barrel. Although they are divesting a little which has fuelled the growth of mergers and acquisitions but they need to do it in a big way.
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Global mergers and India

They are the M(&)arriage mismatches. The nuptial nightmares. The weirdo weddings. Or the Odd Indian Couples. Odd because while they have forfeited every reason to compete in isolation, yet, they continue to do so. While their parent transnationals have merged abroad to increase market share, enhance scale-economies, build R&D muscle, or smother the competition, the Indian subsidiaries continue to eke out solitary existences of their own. Even 3 years after their global mergers, the Indian appendages continue to jealously safeguard their maiden names, maiden brands, and maiden markets. Which, inevitably, threatens their very survival, and adds little value for their shareholders.
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Mergers and Acquisitions It is true that global weddings, being complex multi-market, multi-product, multinational affairs, take time to consummate. Yet, most are impulsive; some are strategic responses to global trends, others are opportunistic over-diversifications. And, by the time a transnational couple's far-flung arms across the world unite, the merger may have lost its meaning. For instance, if a company found eminent logic in taking over its supplier in, say, 1995, it might find the same rationale weak in 1998--when all their operations finally merge--since virtual integration could dictate the contrary by then. Alternately, the strategic logic of a merger in the US, where a predator might be interested in the prey's intellectual property, may cut no ice in India if the latter has only a manufacturing-facility--and hardly any R&D activity. Paradoxical, but possible. The business environment in this country is different from that in the West. In sectors like computers, telecommunications, and foods, the domestic market is not mature enough to warrant consolidation. Not only are they fragmented; they are also in nascent stages of development. And international mergers, fuelled by American stock market booms, have little relevance in this country. Which is why there is such a time lag between a merger announcement abroad and its manifestation locally. The coming together of the Swiss pharmaceutical giants, Sandoz and Ciba-Geigy, for instance, was announced in March, 1996, but their Indian arms continued to operate as separate companies until October, 1997. Delay dogged the American medicinemanufacturers, American Cynamide and Wyeth Laboratories, as well, with a combined Indian entity taking nearly 8 months to emerge. Indeed, India creates quite a few untidy knots in global m&a--glitches that can derail the best-laid gameplans. Its no wonder that for most transnationals, life after a merger actually means starting afresh here. Stated below are some factors and how they affect the companies that have merged world over while trying to come together in India.
Size
India happens to be a remote outpost in a transnational empire. Often, Indian subsidiaries are pygmies compared to their merging parents. When the global pharmaceutical majors, Hoechst, Marion Merrel Dow (mmd), and Roussel, decided to
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Mergers and Acquisitions merge in 1994, for instance, India didn't figure in their strategic priorities at all. After all, mmd did not have a presence in India, and the combined turnover of Hoechst India and Roussel India was a fraction of the sales of the new global entity. Similarly, the $20-billion Union Bank of Switzerland (UBS)-SBC Warburg overshadows its Rs 100-crore Indian operations. Others do not wield enough influence over their global headquarters since they are, practically, start-ups in the Indian market. When the Baby Bells, Bell Atlantic and Nynex, merged globally in 1996, both the companies--which had been operating for less than 2 years in this country--preferred to close down their outfits. For most American companies, the integration process begins in the US, and is followed by Europe, before making its presence felt in Asia. The actual merger pattern in India may be different from the international context. For example, the overseas amalgamation of Sandoz and Ciba-Geigy into Novartis happened differently locally. Internationally, Ciba-Geigy, being a smaller company, was swallowed by Sandoz; in India, Hindustan Ciba-Geigy, being bigger, became the dominant player in the partnership. Even in the case of the American infotech giants, Compaq Computers and Digital Equipment Corp. (DEC), the former took over the latter in the US. Back home, it was Compaq India's turn to be gobbled up. Typically, the insignificance of the Indian market results in a delay of 12-36 months between the time a merger is announced officially and the time its takes effect in India.
Legislation
With India being the market of tomorrow, not today, most transnational subsidiaries are not fully owned by their parents. Quite often, parent corporations are stunned by the nitty-gritty of India's laws, especially the Companies Act, 1956, the guidelines of the Securities & Exchange Board of India, the Factories Act, 1948, the Establishment Act, 1954, and the stamp duties levied by state governments. E.g., the merger of Hoechst Marion Roussel (hmr), which had manufacturing operations at Thane in Maharashtra, was slowed down by legal problems. Moreover, the shackles of policy are difficult to break. For instance, the merger between International Distillers & Vintners (IDY) and United Distillers has got bogged down because both have Indian partners. They independently opted for joint ventures because the norms in the early 1990s stipulated that only Indian companies could become liquor licensees. Since then, the policy has changed, and to complete a global merger in India, the transnationals may have to disengage themselves from their partners
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Labour
Just like international mergers, most Indian ones are accompanied by a painful process of restructuring and downsizing. Yet, there is a fundamental difference between the two. While global mergers are dictated by over-capacity, the minuscule size of the operations in India may not be an adequate justification for a merger. Compulsive restructurings have, often, run into labour problems in an environment where employee and worker unions are strong. Novartis and Glaxo-Burroughs Wellcome, for instance, had to downsize their manufacturing operations in India--a process that has taken about 20 months. So, although Indian mergers have to mirror the global ones--be it in terms of the number of business divisions, the organizational layers, or reporting-levels--the small size of subsidiaries is a blessing in disguise.
Communication
If global mergers are discreet affairs, it is only because of the communications gap between Indian subsidiaries and their employees, and the subsidiaries and their parents. Motivational levels have to be raised internally, but Indian subsidiaries, frequently, get overwhelmed by post-merger fears. To staunch such a hemorrhage, both Thiagarajan and K.N. Shenoy, 65, the then CEO of Hindustan Brown Boveri and the present Chairman of abb India, respectively, visited all the manufacturing facilities of their companies when a merger was announced by Asea and Brown Boveri in 1989. Even as the announcement was made public, both personally wrote to all their employees, assuring them that their jobs would be safe, and that the restructuring would be done in a just manner. Accordingly, abb followed a twopronged strategy: communicating extensively, and restructuring speedily. Selling India and her potential to the global headquarters is critical. The time between the announcement of a merger and its implementation creates a period of uncertainty. Even then, top managers are not privy to information that affects their future. When the Digital-Compaq merger was announced, Som Mittal, 45, the CEO of Digital India, may have been caught unawares
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Stock markets
While global investors bless M&A even before the knot is tied by sending stock-prices to new heights, the local bourses, often, react belatedly. After all, Dalal Street has absolutely nothing to be buoyant about initially. When the Digital-Compaq merger was announced in January, 1998, the Digital scrip rose by almost 25 per cent on Wall Street even though the shareholders of the 2 infotech giants were yet to ratify the merger. Back home, value migrated from Digital, with its share price declining by 3 per cent, signifying that a painful process of transition lay ahead. Today's marriages are tomorrow's uncertainties--if not divorces. And fund-managers know that only too well. Which is why the stockmarket responds indifferently whenever a global merger is announced. . For instance, in the automobile industry, the supplier sector is still in its infancy. Consequently, a global merger between an Original Equipment Manufacturer and a supplier is unlikely to have a value impact in this country.
Take over Code

This is an over view of the take over code just so that one can understand what it is about. I have not gone into the details of the legal aspects of a merger in India. But no talk of the mergers and acquisitions in India is complete without at least a glance at its take over code.
1. Acquirer
a) Any person who directly or indirectly acquires or agrees to acquire either shares or voting rights or b) acquires or agrees to acquire control over the target company either by himself or with any person acting in concert
2. Control
Control has been given an inclusive definition and includes the right to appoint the majority of the directors or to control the management or policy decisions.
3. Persons acting in concert

It means persons who directly or indirectly co-operate by acquiring or agreeing to acquire shares or voting rights for the common objective or purpose of substantial
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Mergers and Acquisitions acquisition of shares or voting rights or gaining control. An inclusive list of the same has been provided for under the code. (Regulation 2(e)(2).)
4. Disclosures:
The Takeover Code require acquirers to make certain disclosures in the following circumstances: Acquisition of shares or voting rights for more than five percent (this five percent would be inclusive of the shares or voting rights already held by the acquirer). Acquisition of shares or voting rights for more than fifteen percent shall necessitate yearly disclosures to the company in respect of such holdings.
5. Takeover Code Trigger:

The Takeover Code is triggered under the following circumstances: Acquisition of shares or voting rights of 15% or more; (this 15% would be inclusive of the rights or shares already held by the acquirer or by the persons acting in concert with him). Acquisition of more than 5% of shares or voting rights in any one year period when the acquirer holds 15% or more but less than 75 % of the shares or voting rights of the company concerned. Acquisition of any additional shares or voting rights when the acquirer already has 75 % of the shares or voting rights of such company.
6. Public Offer
When the Takeover Code is triggered, various requirements are to be complied with by the acquirer, including the making of an open offer to the shareholders from among the general public to acquire a minimum of 20% of the total outstanding paid-up capital of the company. Such announcement should be made within 4 working days of entering into the agreement for acquisition of shares or voting rights.
7. Competitive bid:
Any third person other than the acquirer who has made the first public announcement can make a competitive bid or a counter offer; but has to do so within 21 days of the public announcement of the first offer. Upon the public announcement of this competitive bid, the original acquirer shall have the option to either revise his
73
Mergers and Acquisitions original offer or withdraw it.
8.Exemptions from the Takeover Code:

The public offer provisions of the Takeover Code will not be apply in the following cases: Allotment in pursuance of an application made to a public issue; Allotment pursuant to an application made by the shareholder for rights issue, Subject to such rights issue not resulting in change in control and management of the company; Preferential allotment of shares, subject to the condition that at least 75% of the shareholders of the company shall have approved the preferential allotment and that sufficient disclosures relating to the post-allotment shareholding pattern, offer price etc., have been made to the shareholders; Allotment to the underwriters pursuant to any underwriting agreement;
Issue of American Depository Receipts and Global Depository Receipts or Foreign Currency Convertible Bonds, till such time as they are not converted into equity shares; Shares held by banks and financial institutions by way of security against loans in addition to the above cases, even when there is a change in control and management of the company, the Takeover Code would still not apply if at least 51% of the shareholders of the company have approved the acquisition by the
Acquirer after being made aware that such acquisition would result in change in control and management.
CASE STUDIES
1. Sesa Goa-Mitsui
In 1996, Mitsui of Japan acquired the parent company of Sesa-Goa India Limited, a publicly traded listed company in India. As a result of this acquisition, Mitsui indirectly became the single largest shareholder of Sesa-Goa. The question then raised was whether Mitsui should make an open offer to other shareholders of Sesa-Goa under
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Mergers and Acquisitions the Takeover Code. Mitsui applied to SEBI stating that the Takeover Code should not be triggered as the change in control of Sesa-Goa was a result of its acquisition of Sesa-Goa's parent. Luckily for Mitsui, the case was evaluated under the 1994 takeover code and the Ministry of Finance ruled that under the 1994 takeover code, SEBI had no jurisdiction over the developments abroad and therefore could not pass sentence on something that happened outside its jurisdiction and thereby no open offer was required. Under the Takeover Code, Regulation 3(j)(ii), acquisition of shares in companies pursuant to a scheme of arrangement or reconstruction including amalgamation or merger or demerger under any law or regulation, whether Indian or foreign has been exempted from the public offer provisions. However, prima facie it does not exempt international acquisitions or mergers carried out under normal course of business as a result of which there is a change in control of an Indian listed company. For that matter, the Code defines control very broadly to include both direct or indirect control.
2. Schenectady International Inc.

In case of Schenectady International Inc. of USA (the "acquirer"), the acquirer filed an application with SEBI seeking exemption from the application of public offer provisions of the Takeover Code for its acquisition of 51% of the equity capital of Dr. Beck & Co. (India) Limited (the "target"). The acquirer proposed to acquire 32.67% and 18.33% of the target from Beck and BASF AG of Germany respectively. The acquirer in its application stated that this acquisition of 51% of the target company was a part of the global acquisition of the Beck division from BASF which includes BASF and Beck's equity holding in the target company. The acquirer contended that such an acquisition will be covered under the Regulation 3(j)(ii) of the Takeover Code and hence it should be exempted from the applicability of the public offer provisions. The Takeover Panel rejected above application and accordingly SEBI ordered the acquirer to make open offer for 20% to the public.
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Case Study
I have studied the merger of ICICI bank with Bank of Madura. In this chapter I have a given a synopsis of my findings so that at one glance one can see what the combined enterprise would look like and the reasons and the problems that the merger is likely to face. First I would like to look at why world over banks are merging? World over banks have been merging at a furious pace for mainly three reasons: They are driven by an urge to gain synergies in their operation, To derive economies of scale To offer one stop facilities to a more aware and demanding consumer. What will acquiring banks look for while choosing their targets? Financial viability Strong geographical reach and large asset base. Staffing/employee costs and Technological infrastructure will also play an important role in acquiring target banks. Valuations will also play a strong role in bank mergers like in any other case of mergers and acquisitions.
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The Case: ICICI and Bank of Madura

The take over of Bank of Madura (BoM) by ICICI Bank has been the second success story in the banking industry after the take over of Times bank by HDFC Bank last year. The Board of Directors of ICICI Bank and Bank of Madura (BoM) approved the merger of the two banks at their respective meetings held on 11thDecember and agreed to a share swap ratio of two shares of ICICI Bank for one share of BoM. The amalgamation scheme was placed for approval at the meeting of shareholders of the two banks on January 19 .The proposed date of merger was February 1, 2001. ICICI Bank Limited has fixed Wednesday, April 11, 2001 as the 'Record Date' to determine the shareholders of Bank of Madura Limited who would be entitled to receive the equity shares of ICICI Bank. ICICI Bank was third time lucky after two earlier attempts of merger. The first was a proposed merger with Centurion Bank, which fizzled out after the banks promoters asked for higher valuations, the second a recent reverse merger with parent ICICI. The integration exercise was scheduled to be completed by September 2001. Before we move onto why the two banks decided to merge. Let us look at why ICICI decided to merge with Bank of Madura?
77
Mergers and Acquisitions ICICI Bank had been scouting for a private banker for merger. Though it had 21 percent of stake, the choice of Federal bank, was not lucrative due to the employee size (6600), per employee business is as low at Rs.161 lakh and a snail pace of technical up gradation. While, BOM had an attractive business per employee figure of Rs.202 lakh, a better technological edge and had a vast base in southern India when compared to Federal bank.
Some key financials of both the banks: Financial Standings of ICICI Bank and Bank of Madura (Rs. in crore) Parameters ICICI Bank 19991998-99 2000 Net worth 1129.90 308.33 Total Deposits 9866.02 6072.94 Advances 5030.96 3377.60 Net profit 105.43 63.75 Share capital 196.81 165.07 Capital Adequacy Ratio 19.64% 11.06% Gross NPAs/ Gross 2.54% 4.72% Advances Net NPAs /Net 1.53% 2.88% Advances Bank of Madura 19991998-99 2000 247.83 211.32 3631.00 3013.00 1665.42 1393.92 45.58 30.13 11.08 11.08 14.25% 15.83% 11.09% 6.23% 8.13% 4.66%
Source: Compiled from Annual reports (March 2000) of ICICI Bank and BOM
Illustration 13 Crucial Parameters: How they stand Name ofBook value ofMarket price onEarnings Dividend P/E ratio Profit the Bank Bank on the daythe of day ofper share paid %) (in mergerannouncement (in
per lakh)
employee
78
Mergers and Acquisitions announcement of merger of 183.0 131.60 58.0 169.90 1999-2000 38.7 5.4 55% 15% 3% 1.73 7.83 Illustration 14
Bank Madura ICICI Bank
Source: Business Line, December 10, 2000and January 28, 2001.
Reasons for the merger:

BoM was bankrupt (with assets which are Rs.350 crore behind liabilities) and had a leverage of 41 times. If it were to be brought up to a point where its assets were 10% ahead of liabilities, which is broadly consistent with the Basle Accord, this would require an infusion of Rs.800 crore of equity capital, which would be impossible for them to raise. BoM had a network, which ICICI Bank wanted. They had many regional branches, which would help ICICI increase their reach in the regional markets. Financial consolidation was becoming necessary for the growth of BoM. The merger with a new private sector bank, particularly a financially and technological strong bank like ICICI would add to shareholder value and enhance career opportunities for the employees besides providing first rate, technology based, modern banking services to customers A major problem for old banks is funds. Reserve Bank of India has asked several South India based banks to raise their paid-up capital to Rs 50 crore by March 2001. This could also be one of the reasons that they merged. BoM is extremely strong in the south and this merger would help ICICI grow in that area. ICICI wanted to increase their client base.
Benefits
For BoM, the most significant benefit would be the brand equity it would acquire by becoming a part of the ICICI group, with the most overt advantage being technology infusion.
79
Mergers and Acquisitions BoM would not have been able to raise the Rs800 crore that it needs to get the assets 10% ahead of its liabilities, but after the merger with ICICI this amount will be infused into the bank. The shareholders of both the banks will benefit. Although the swap ratio favours BoM the ICICI bank shareholders still earn a higher Earning per Share (EPS). o On post merger, ICICI Bank's equity shall be Rs.220.36 crores while its annual total income would be about Rs.1,700 crores with expected net profit of Rs.192 crores giving an annualised EPS of Rs.8.70 as compared to an EPS of Rs.7.90 as on 30 September. 2000 Hence it has been seen that even after issue of shares in exchange ratio of 2:1 the financial performance of the bank shall improve, thus improving the bottom line of the bank. o Even the shareholders of Bank of Madura stand to gain, as now they will have double quantity of ICICI Bank shares. The share price of Bank of Madura had a 52-week high/low of Rs.165 and Rs.65 prior to announcement of merger, with the average being Rs.120.after the merger; the value of one share shall rise to anything between Rs.280 to Rs.300, since the share price of ICICI Bank rules above Rs.150. So the shareholders of this bank have almost trebled their worth. ICICI Banks growth prospects had improved, as it would now get access to the branch network of Bank of Madura. o The bank was looking at a branch network of 350-400, which would have taken at least five years to achieve. BoM has a branch network of 263 while ICICI Bank has 106 branches so totally they would have 363 branches, which would enable them to serve their customers better. Thus the merger would provide this network immediately and would enable them spread their network to 16 States. o The enhanced branch network will enable the Bank to focus on microfinance activities through self-help groups, in its priority sector initiatives through its acquired 87 rural and 88 semi-urban branches. The cost of setting up the branches would have been Rs2-2.6b. Of these branches, 50-60
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Mergers and Acquisitions are located in major cities where ICICI Bank did not have a significant presence. On an average, Bank of o Madura s metropolitan branches have mobilized deposits of over Rs300m whereas ICICI Bank has been mobilizing deposits of over Rs1b per branch. ICICI Bank expects to generate the same amount of deposits from the acquired branches without incurring the set-up costs.
Larger Client base: To get an additional 1.2 million customers, which is BoM's client base now, it would have required a minimum of two years. Hence they get 1.2 million customers in one go, this is significant especially when viewed in the light that ICICI Bank took almost 7 years to build a customer base of 1.9m.Thus, the merger enables ICICI to have an aggregate of 2.7 million customer base and a combined asset base of Rs.16, 000 crore, cross selling opportunities for assets and other products, and good cash management services.
BoM is strong in south India states and ICICI is very strong in Central and North Indian states, which would give a complacent advantage to both the banks. The south has a high rate of economic development. This merger has enabled ICICI Bank to gain a size and presence, which on its own would have taken around 2-3 years. Moreover, it also opens up the south Indian market for the bank where it had a very low presence earlier. The south is considered to be a big retail market, which has been untapped by the new generation private sector banks. This merger will provide ICICI Bank with a significant lead in this region. Whereas it would give BoM a chance to explore the Northern Terrotories.
Financial Capability: The amalgamation will enable them to have a stronger financial and operational structure, which is suppose to be capable of greater resource/deposit mobilization. And ICICI will emerge as one of the largest private sector banks in the country.
Tech edge: The merger will enable ICICI to provide ATMs, Phone and the Internet banking and financial services and products to a large customer base, with expected savings in costs and operating expenses.
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Mergers and Acquisitions An Acquisition at a fair value.. ICICI Bank issued 23m shares (which increased its equity from Rs1.97b to 2.2b) to Bank of Madura shareholders in an all-stock swap deal. The ICICI Bank stock was quoting at an average of Rs140-150 during that period which means that the total deal was worth Rs3.25-3.5b. BoM would not have to close down due to bankruptcy. It gets a new lease on life.
An opportunity to improve fee-based income The merger will help ICICI Bank to improve its fee-based income. Bank of Madura was one of the active players in cash management services and was even used by some of the foreign banks because of its efficient service standards. ICICI Bank can use this client base to substantially shore up its fee-based income, which is expected to be the differentiating factor in the revenue models of banks in the future.
Problems in the merger:

The employees and staff of the two banks had no clue whatsoever and were `surprised and shocked' in their own words when the merger was announced. Hence they might make the merger process more tiresome for the management. The surprise element is said to have hit even the top management of Bank of Madura who are reported to have been "caught unawares" by the developments set in motion by the owners/directors of the two banks. It is a merger of a 57-year old BOM, south based old generation bank with a fast growing tech savvy new generation bank this in itself has enough problems. Managing rural branches : ICICIs major branches are in major metros and cities, whereas BOM spread its wings mostly in semi urban and city segments of south India. There is a task ahead lying for the merged entity to increase dramatically the business mix of rural branches of BOM. On the other hand, due to geographic location of its branches and level of competition, ICICI Bank will have a tough time to cope with.
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Mergers and Acquisitions Managing Software: Another task, which stands on the way is technology. While ICICI Bank, which is a fully automated entity is using the package, Banks 2000; BOM has computerized 90 percent of its businesses and was conversant with ISBS software. The BOM branches are supposed to switch over to Banks 2000. Though it is not a difficult task, with 80 percent computer literate staff would need effective retraining which involves a cost. The ICICI Bank needs to invest Rs.50 crore, for upgrading BOMs 263 branches. Managing Human resources: One of the greatest challenges before ICICI Bank is managing human resources. When the head count of ICICI Bank is taken, it is less than 1500 employees; on the other hand, BOM has over 2500. The merged entity will have about 4000 employees which will make it one of the largest banks among the new generation private sector banks. The staff of ICICI Bank are drawn from 75 various banks, mostly young qualified professionals with computer background and prefer to work in metros or big cities with good remuneration packages. While under the influence of trade unions most of the BOM employees have low career aspirations. The announcement by H.N. Sinor, CEO and MD of ICICI, that there would be no VRS or retrenchment, creates a new hope amongst the BOM employees. It is a tough task ahead to manage. On the other hand, their pay would be revised upwards. It is a Herculean task to integrate the two work cultures. Managing Client base: The client base of ICICI Bank, after merger, will be as big as 2.7 million from its past 0.5 million, an accumulation of 2.2 million from BOM. The nature and quality of clients is not of uniform quality. The BOM has built up its client base for a long time, in a hard way, on the basis of personalized services. In order to deal with the BOMs clientele, the ICICI Bank needs to redefine its strategies to suit to the new clientele. The sentiments or a relationship of small and medium borrowers is hurt, it may be difficult for them to reestablish the relationship, which could also hamper the image of the bank.
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Effect / how the integrated company would look:

The total assets of the merged entity would prove to be roughly Rs.17, 345 crore and the liabilities would prove to be Rs.16, 517 crore. The merged entity would hence need roughly Rs.800 crore of fresh equity capital in order to come up to a point where assets were atleast 10% ahead of liabilities as mentioned above. The volatility of assets of the merged entity proves to be around 0.12
ICICI would become the no. 1 private bank in the country and would beat its competitor HDFC bank. HDFC BANK + TIMES BANK 116.5 46.3 1.4 131 207 ICICI BANK + BANK OF MADURA 163.7 70.3 3.2 389 510 Illustration 15
(FY01)
Deposits (Rs b) Advances (Rs b) No. of retail accounts (m) Branches ATMs Increased NPAs
Illustration 16
84
For the FY01 ICICIs net NPAs would increase marginally to 1.44% of customer assets, because of the assets quality of the BoM as the assets and liabilities are combined as of 31st March 01. However ICICI has taken steps to control the NPA. To control its NPAs as a matter of policy, unlike earlier, the bank has given credit approval authority to only selected branches, which would be having the required expertise to assess the credit risk. While the approval would be only at selective branches, which was not the case earlier, actual disbursement can be from other branches for locational convenience. It has also decided as a matter of policy to extend advances to only top rung companies in each sector. These new policy measures we believe would go a long way in improving the quality of assets in future and keeping NPAs under check.
Share holding pattern. Category ICICI ADS Resident Indians BoM Shareholders FIIs Others Total % 46.99 14.41 6.14 10.68 17.26 4.52 100 Illustration 17
Rationale for the swap ratio. The ICICI Bank-Bank of Madura (BoM) swap ratio is 2 shares of ICICI to one share of BoM, though it is in favour of BoM, it has to be viewed in the light that the book value of the latter's shares is about 3.8 times that of the acquiring bank. The book value per share of ICICI Bank is Rs 61.90 while that of BoM is Rs 232.80 and this was a major factor in determining the exchange ratio. The operating profit
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Mergers and Acquisitions margin of BoM is also higher at 33.3 per cent, than that of ICICI Bank, whose margin works out to 31.8 per cent. The net profit margin of ICICI Bank is 16.8 per cent and that of BoM is 13 per cent. To sum up I would like to say that if ICICI Bank is not able to achieve synergies and increase the projected growth targets after the acquisition of BoM, it will adversely affect the future growth of ICICI Bank also.
Summary of Interview
Mr. Ranjit Dongre
Senior manager Advisory services HSBC
Lets take a look at what happens in the real world. Is everything done the way it should be? Very often CEOs of companies that are doing badly go in for a merger or an acquisition because they want to keep their job. They need to show that something is happening that they are doing something to improve the current situation of the company. Usually the benefits expected from a merger are never accrued. Due diligence is extremely important and can take from anywhere between 3 to 4 days upto 1 to 3 months. Usually though only accounting and financial due diligence is done. Financial due diligence for a Rs.100 crore company can be done in 10 days. Usually though the due diligence is done by accounting firms and all the banks actually do is get the two companies together and supervise. People form the softer cultural aspect of the merger. Usually they are ignored in mergers since the CEOs have their own priorities. People can ruin the cost structure of the merger and they may cause it to become inefficient but it cannot break a merger. It does not drive mergers. A successful merger is when inherent value is created for the shareholder. For example:
86
Mergers and Acquisitions If I am currently making a profit of Rs.10 every year and if I take over another company my revenue and my market share goes up but along with that if I start making a profit of Rs.40 then I have created value. A slump sale is when you acquire the entire business not just the facilities. In India mergers are predominant in the cement, telecom, pharma , media and IT sector and these are the areas that one is likely to see mega mergers happening. Since these are relatively new and highly competitive sectors. In the future if you are a small player you will be gobbled up. Finally only the big players will survive. The competition will narrow down tremendously.
Miss. Hemal Salot Associate Lazard International

The motives for a merger or an acquisition can be explained through two mergers: Sony and Ericsson : They merged because telecom was in a swamp. They had excess capacity because the demand levels did not meet their expectations. So they had to gain some stability and economies of scale. HP and Compaq: They wanted to be no.1 in the market, they wanted higher market share, wider range of products and economies of scale. Other reasons are that you get strength against competition, better manpower, and better skill. The success rate of mergers and acquisitions transactions is 1 to 5 %. The biggest problem arises in the transition phase because there is so much change and people are not ready to accept it. It is a nightmare to integrate cultures and people. The synergy benefits depends on why the merger has taken place if it is for the purpose of geographical expansion then the benefits will accrue. Cable and wireless has acquired 40 companies in a year. However they did not integrate the companies but each one functions as a stand alone entity. Therefore there were minimal integration problems. Growth through mergers and acquisitions is called inorganic growth. It is not internal but external means of growth.
87
Mergers and Acquisitions In India the scenario is bad right now. The two reasons that it is bad is because : The people are not receptive They are very family oriented they dont want to sell the business and move on.
But now they have to change because of the international companies coming in people will have to sell out unless they have a niche market. Through both these interviews one can see that the practical aspects of mergers and acquisitions are not so different from the ones that we read in our text books.
Conclusion
Weve achieved our target
You can almost hear the sigh of relief from everyone seated in the boardroom. Months of sleepless nights and hours of work have boiled down to this one-day and yes they have been victorious. This line, this scene is the dream of every company that goes in for a merger or an acquisition. To achieve the set target is a remarkable feat considering the fact that most mergers dont succeed. Over the years there have been millions of mergers, the value of which keeps increasing as the years go by, but yet no one has been able to come up with a sure shot formula for success and no one probably ever will. One of the main reasons for this is that every organization is different from the other, no two firms have the same work cultures and philosophies, just like no two people in the world are exactly similar. The requirements for success for each firm would differ. This does not mean that the organization does not strive to achieve success or that it is out of reach. It is not. The company should work towards their set goals. The issues that I have discussed in the report should be looked at closely, because if theyve done
88
Mergers and Acquisitions everything right and it still does not work means that they were a misfit form the beginning. Before making a final deal they must do a due diligence. This will help them in uncovering any facts that might not be blatantly visible but can cause a hindrance to the merger. The people who have a stake in the firm, be it employees or customers should be informed about the going-ons in the company. This would assure their full support to the firm. The price structure should be studied in detail. The company should be on their toes all the time making sure that the competitor is not taking advantage of their vulnerable position when they are in the process of a merger or an acquisition. The scope of mergers is tremendous because there are so many fragmented players especially in India, they would not be able to withstand competition from the multinationals. Today in a lot of sectors there is fierce competition like telecom, this excessive competition at some point of time will lead to consolidation in the industry because they cannot keep playing price games, at some point they will have to stop. Fixed costs are rising, consumers are becoming global, their demands have to be serviced and mergers are considered to be the simplest way to expand since you dont incur the
To conclude I would like to say that this is just the beginning... The best is yet to come the
marriages are going to get bigger and bigger start-up costs.
To conclude I would like to say that this is just the beginning.. the best is yet to come.. the marriages are going to get bigger and bigger.
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Books
Mergers and Takeovers a Compendium Bombay Chartered Accountants Society Mergers and Acquisitions Hitt , Harrison and Ireland Big Deal Bruce Wasserstein
Bibliography Newspapers
Financial Express The Economic Times Business Standard The Hindu Business Line The Times of India
Magazines
Business Today The Economist
Websites
www.icfai.com www.mckinsey.com www.mergersindia.com www.uva.edu www.google.com www.altavista.com www.yahoo.com www.valuenotes.com www.krchoksey.com 90

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Mergers and Acquisitions

Mergers and Acquisitions

Mergers and Acquisitions

Mergers and Acquisitions

Merger: It is the combination of 2 or more companies into a single company

Amalgamation: Halsburys Laws of England describe amalgamation as a

Consolidation: Technically speaking consolidation is the fusion of two

Acquisition: An acquisition is the purchase by one company of a controlling

Takeovers: A takeover bid is the acquisition of shares carrying voting rights in a

Demerger: It means hiving off or selling off a part of the company. It is a

Different types of mergers:

Horizontal Merger: It is a merger of two or more competing companies,

Vertical Mergers: It is a merger of one company with another, which is

Conglomerate Mergers: It is an amalgamation of 2 companies engaged

Concentric Mergers: This is a mild form of conglomeration. It is the

Consolidation Mergers: It involves a merger of a subsidiary company

Ways of handling a merger or an acquisition:

Friendly merger: a merger whose terms are approved by the

Hostile merger: A merger in which the target firms management

Proxy Fight: an attempt to gain control of a firm by soliciting

Mergers and Acquisitions

The M&A Terminology

Spin-off: Spin-off has emerged as a popular form of corporate downsizing. A new

Leveraged Cash Out: A target company would issue debt instruments,

White Knight: White Knight strategy involves selecting of a lesser evil.

Mergers and Acquisitions

Greenmail: Greenmail is a form of targeted share repurchase. It refers to the

Golden Parachutes: Golden Parachutes are agreements that provide for

Leveraged Buyout (LBO): This is an innovative way of financing an

Mergers and Acquisitions

Reasons for Mergers and Acquisitions

Essential Strategy: Companies are beginning to learn what nations have

To maintain profitability: To assure profits, firms, which find

Dispersion of technology: Technology becomes available to everyone,

Increasing importance of fixed costs: To compete in the global

corporate strategy: Mergers and acquisitions should be seen in light of

Tax considerations: This has stimulated a lot of mergers and acquisitions.

Managers personal incentives: Financial economists like to think

Why they do not succeed?

High cost of financing: A study conducted by Mckinsey shows that 60%

The potential for managerial hubris: This may preclude an

Failure to integrate: diverse cultures, structures and operating systems of

Mergers and Acquisitions

Failure to do proper due diligence: during the pre-merger or

Bankruptcy of strategy: There is a strong belief that mergers and

Employees of the organization:

Anatomy of a merger and acquisition transaction

Post- deal stage

Problems at the various stages in the Merger or Acquisition process:

Creating a structure for the merged company

Gather information about each company.

Merging the operations

Mergers and Acquisitions Them and us continues.

An integrated salary and benefit structure should be implemented as soon as possible

Creating a new unified company

The stronger party at executive level

The stronger party at staff level

The weaker party at executive level

The weaker party at staff level

Mergers and Acquisitions

Types of Due Diligence:

Technical due diligence:

Human Resource due diligence: