Professional Documents
Culture Documents
Copyright www.educorporatebridge.com
Introduction
Copyright www.educorporatebridge.com
MERGER
ACQUISITION
A combination of two companies to form a new entity, in which the individual companies cease to exist.
For example, in the 1999 merger of Glaxo Welcome and SmithKline Beecham, both firms ceased to exist when they merged, and a
new company, GlaxoSmithKline was created.
One company acquires other company, in which the company being acquired (c/d as target co.),ceases to exist and becomes a part of
the acquiring co. and no new co. is formed.
For example, Tata Steel acquired Corus for $12.2 bn in 2007.
TAKEOVER
3
Copyright www.educorporatebridge.com
Types of M&A
HORIZONTAL MERGER
VERTICAL MERGER
CONGLOMERATE MERGER
4
Copyright www.educorporatebridge.com
Types of Acquisitions
FRIENDLY ACQUISITION
HOSTILE ACQUISITION
Target has no desire to be acquired and actively rebuffs the acquirer and refuses to provide any confidential information.
5
Copyright www.educorporatebridge.com
There is not one single reason for a merger or takeover but a multitude of reasons
(1)
Synergy means working together. The gains obtained by working together by amalgamated undertakings result into synergistic operating
gains.
These gains are most likely to occur in horizontal mergers in which there are more chances for eliminating duplicate facilities. Vertical and
conglomerate mergers do not offer these economies.
The worth of the combined undertaking should be greater than the sum of the worth of the two separate undertakings i.e. 2+2 = 5.
(2)
(3)
DIVERSIFICATION
Mergers and acquisitions are motivated with the objective to diversify the activities so as to avoid putting all the eggs in one basket and
obtain advantage of joining the resources for enhanced debt financing and better serviceability to shareholders.
TAXATION ADVANTAGES
Mergers take place to have benefits of tax laws and company having accumulated losses may merge with a profit earning company that will
shield the income from taxation.
Section 72A of Income Tax Act, 1961 provides this incentive for reverse mergers for the survival of sick units.for e.g. acquisition of Global
Trust Bank(GTB) by Oriental Bank of Commerce(OBC).
6
Copyright www.educorporatebridge.com
Mergers and acquisitions are motivated with a view to sustain growth or to acquire growth.
To reduce capacity of production merger is sometimes used as a tool particularly during recessionary times as was in early 1980 in USA.
The technique is used to nationalize traditional industries.
Managers benefit in rank, status and perquisites as the enterprise grows and expands because their salaries, perquisites and status often
increase with the size of the enterprise.
The acquisition of a company can be had by the management personnel. It is known as management buyout. This practice is common in
USA for over 25 years and quite in vogue in UK. Management may raise capital from the market or institutions to acquire the company
on the strength of its assets, known as leveraged buyouts.
7
Copyright www.educorporatebridge.com
Acquirer may purchase the specific assets of the acquiree rather than acquiring the whole undertaking with assets and liabilities.
There can be many situations to take over the assets of a company at discount viz.
(i)
The acquiree may be in possession of valuable land and property shown at depreciated value/historical costs in books of account
which underestimates the current replacement value. Thus, acquirer shall be benefited by acquiring the assets of the company and
selling them off subsequently;
(ii)
To acquire non-profit making company, close down its loss making activities and sell off the profitable sector to make gains;
(iii)
The existing management is incapable of utilizing the assets, the acquirer might take over unguarded company and increase its debt
secured on acquirees assets.
Many times a company acquires its competitor to increase its market share and increase sales. The best example is Grasim acquisition of
L&T (Cement division).
There may be many other reasons motivating mergers in addition to the above ones viz. profit enhancement for the company, achieving
efficiency, increasing market power, tax and accounting opportunities, growth as a goal and many speculative goals etc. depending upon
the circumstances and prevailing conditions within the company and the economy of the country.
8
Copyright www.educorporatebridge.com
Horizontal Merger
Economy of scale
Synergy
Reduction of competition
Technology up gradation
Tax benefits
Vertical Merger
Cost Advantage
Conglomerate Mergers
Diversification
9
Copyright www.educorporatebridge.com
Example
10
Copyright www.educorporatebridge.com
The Process
Negotiations
11
Copyright www.educorporatebridge.com
12
Copyright www.educorporatebridge.com
An Investment Banker to help you find the right candidate and in arriving at the right value of your
target.
An M&A attorney who is experienced with such transactions to help you overcome the legal
hurdles.
A tax attorney
13
Copyright www.educorporatebridge.com
Swap Ratio
The ratio in which an acquiring company will offer its own shares in exchange for the target
company's shares during a merger or acquisition.
For example, if a company offers a swap ratio of 1:1.5, it will provide one share of its own company for every 1.5 shares of the
company being acquired.
To calculate the swap ratio, companies analyze financial ratios such as book value, earnings per share, profits after tax and dividends
paid, as well as other factors, such as the reasons for the merger or acquisition.
The swap ratio determines the control that each group of shareholders of the companies will have over the combined firm. It is an
indicator of relative values of financial and strategic results of the company.
14
Copyright www.educorporatebridge.com
PRE-MERGER
COMPANY A
C OMPANY B
PAT
6,25,000
2,50,000
No. of Shares
2,00,000
1,00,000
EPS
3.125
2.5
P/E Ratio
7.5
Market Price/Share
25
18.75
Market Value
50,00,000
18,75,000
15
Copyright www.educorporatebridge.com
POST-MERGER
SITUATION 1
SITUATION 2
Swap Ratio
2.5:3.125 = 0.8
1:1
PAT
6.25+1.25 = 8.5
8.5
No. of Shares
2.0+0.8 = 2.8
2.0+1.0 =3.0
EPS
8.5/2.8 = 3.125
8.5/3.0 = 2.91
P/E Ratio
7.5
Market price/Share
8*3.125 = 25
8*2.91 = 21.825
25*2.8 = 70,00,000
21.825*3.0 = 65,47,500
16
Copyright www.educorporatebridge.com
Swap Ratio
CONCLUSION
Exchange at EPS
17
Copyright www.educorporatebridge.com
Payment by Cash
Payment by Stock
18
Copyright www.educorporatebridge.com
Poison Pill
A strategy used by corporations to discourage hostile takeovers by making its stock less attractive to the acquirer. There are two types
of poison pills:
A "flip-in" allows existing shareholders to buy more shares at a discount there by diluting the shares held by the acquirer
A "flip-over" allow stockholders to buy the acquirer's shares at a discounted price after the merger.
Golden Parachute
This measure discourages an unwanted takeover by offering lucrative benefit it's to the current top executives, who may lose their job
if their company is taken over by another firm.
Golden parachutes can be prohibitively expensive for the acquiring firm and, therefore, may make undesirable suitors think twice
before acquiring a company.
19
Copyright www.educorporatebridge.com
White Knight
If a determined hostile bidder thwarts all defenses, a possible solution is a white knight, a strategic partner that merges with the target
company to add value and increase market capitalization. A good example of this is the acquisition of Bear Stearns by white knight
JPMorgan Chase in 2008
Greenmail
A company may also pursue the greenmail option by buying back its recently acquired stock from the putative raider at a higher price
in order to avoid a takeover.
20
Copyright www.educorporatebridge.com
Impact of M&As
Impact On Shareholders
The investors may share the risk in case of a stock transaction and may gain or lose depending upon whether the merger or
acquisition adds to the value of the firm (the post-merger fluctuations in share price).
The employees of the target company may be retained or can be fired by the new management.
The customer may stand to gain or lose depending upon whether the expected synergy is realized or not post-merger.
Impact On Management
The management of the existing company is usually retained in case of a merger or a friendly acquisition.
The management of the target company is often replaced in case of a hostile acquisition/takeover.
The Share price post-merger will increase if the merger or the acquisition adds to the value of the existing company and the expected
synergy is realized. For example,
The Share price post-merger will come down if the expected synergy is not realized. For example,
21
Copyright www.educorporatebridge.com
Pros
Cons
Increase in sales/revenues.
22
Copyright www.educorporatebridge.com
Accounting for
Merger/Acquisition
23
Copyright www.educorporatebridge.com
Acquisitions can be accounted for using two methods, acquisition (purchase) and merger
(pooling).
When the pooling of interest method is used, the balance sheets of the two businesses are combined and
no goodwill is created.
Because a merger transaction does not create goodwill, acquisition-related amortisation expenses do not
impact pro forma earnings.
When the purchase method is used, the acquiring company will put the premium they paid for the other
company on their balance sheet under the "Goodwill" category.
Accounting rules require the goodwill be amortized over the course of 40 years and will show amortization
expenses related to goodwill, lowering down the reported pro forma earnings.
As the consolidated income statement in subsequent periods, in the purchase method will
show amortization expenses related to goodwill, and, therefore will lead to lower reported
Earnings, as a concession, the FASB will no longer require goodwill to be written off unless
the assets became impaired. Goodwill can now only be impaired under these
standards.
24
Copyright www.educorporatebridge.com
Pooling method
A buys B
A buys B
Accounting deal
A buys B
A buys B
Goodwill
No goodwill
Combine financial results from the date of Combine financial results for the entire
merger
period reported
Consideration
Certain
restrictions
on
type
considerations, typically 90% stock
of
25
Copyright www.educorporatebridge.com
Asset acquisition
The acquirer buys some or all of the target's assets/liabilities directly from the seller. If all assets are
acquired, the target is liquidated.
Stock acquisition
The acquirer buys the target's stock of from the selling shareholders.
Note that in a stock sale, the sellers are the target's shareholders (which may be a
corporate entity). In an asset sale, the seller is a corporate entity.
So, the type of acquisition will determine who pays taxes on the transaction and the amount
of taxes to be paid based on the tax rate applicable to the seller.
Do not confuse the type of acquisition with the form of consideration. A buyer may use either
cash or stock (or a combination thereof) as consideration for the assets or stock of the
target.
26
Copyright www.educorporatebridge.com
Asset acquisition
In an asset sale, individually identified assets and liabilities of the seller are sold to the acquirer.
A major tax advantage to the acquirer of structuring a transaction as a taxable asset purchase is that the
acquirer receives stepped-up tax basis in the target's net assets (assets minus liabilities).
In a taxable asset sale, the seller pays tax on any gain on the sale of its assets.
Stock Acquisitions
In a stock purchase, all of the assets and liabilities of the seller are sold upon transfer of the seller's stock
to the acquirer.
The acquirer does not receive a stepped-up tax basis in the acquired net assets but, rather,
a carryover basis. Any goodwill created in a stock acquisition is not tax-deductible.
However, if an Internal Revenue Code (IRC) Section 338 election is made by the acquirer (or jointly by
the acquirer and seller), the stock sale is treated as an asset sale for tax purposes.
In an asset acquisition, net assets are written up for both book and tax purposes. In a stock
acquisition, on the other hand, net assets are written up for book purposes but not for tax
purposes, giving rise to a DTL.
27
Copyright www.educorporatebridge.com
They avoid double taxation (i.e. At the corporate level and at the shareholder level) and
Receive a step-up in the tax basis of the assets and, as a result, higher tax-deductible depreciation
expense;
28
Copyright www.educorporatebridge.com
Assets /
Liabilities
Complexity
/ Cost
Taxes
Tax Basis
Goodwill
Asset Deal
Stock Deal
29
Copyright www.educorporatebridge.com
30
Copyright www.educorporatebridge.com
Combination analysis
Combination analysis is often used in M&A for mergers of equals between two public companies or when a
public company purchases a business (public or not) for cash/stock/debt/mix of considerations.
It creates a profile of the combined company and the credibility of a proposed combination is based on
how and by how much the pro forma combined entity has changed from the standalone positions, based
on several metrics that should be included in a combination model.
31
Copyright www.educorporatebridge.com
Typical uses
The analysis can be used to gauge the potential market reaction to a combination based on the impact on
EPS, cash flow per share, credit ratios, and ultimate ownership of the pro forma entity.
The majority of models provide sensitivity analysis to view how key measures are affected should certain
factors be varied.
Determining how much your client can afford to pay for a potential acquisition
32
Copyright www.educorporatebridge.com
33
Copyright www.educorporatebridge.com
As the majority of M&A transactions will be acquisitions, and hence subject to purchase
accounting, the building of a combination model will focus only on acquisition/purchase method.
1.
2.
3.
4.
34
Copyright www.educorporatebridge.com
Key Inputs
The first step in building a combination model is to populate it with the required inputs.
Whatever the format of the model, the key starting inputs remain the same:
Variable
Stock price
Forecast average shares
Purchase premium
Synergy(revenue
enhancements/cost savings)
Interest rate, exchange rate
Financials/EPS forecast
Options outstanding
Average option price
Dividend payout
Transaction costs
Asset write-ups
Hints/issues
Source
Use dosing price
Data stream Bloomberg
Use latest shares outstanding as a proxy Annual report or interim, Bloomberg
for base
Check for any share issues, buyouts
since then.
Use a rounded number
Transaction comps
Industry specific
Often expressed as percentage of targets Cost saving comps
sales or EBITDA
Relevant 5-year government benchmark Data stream, Bloomberg, Financial
and spread
Times
Differentiate between forecasts and Research Reports, Analyst research
consensus common sense is required to
decide on suitable forecasts
Do not confuse with exercisable options
Annual report (note)
Take an average of low and high
Annual report (note)
LTM dividend payout ratio
Analyst estimates
Estimate of M&A /legal fees and Transaction costs comps
miscellaneous costs
Generally assumed to be zero in
Simple models, Industry specific
35
Copyright www.educorporatebridge.com
Transaction Assumptions
One of the key stages in building a combination model is in deciding on the transaction
assumptions. All the key drivers that determine the structure of a transaction should be
presented clearly including:
Transaction expenses
Calculation of synergies
36
Copyright www.educorporatebridge.com
Synergies
Goodwill amortization
Tax on the above items (note that goodwill amortization is generally not tax deductible in most countries, although it is tax
deductible in Germany)
The steps required to complete the pro forma profit and loss account are as follows:
1.
Lay out the stand-alone profit and loss account of each company
2.
3.
In preparing the profit and loss account, the profit and loss items of both companies can generally be
added together. However, adjustments will be required for the following:
Enter the appropriate adjustments, including (if applicable) annual goodwill amortized, additional interest/expense,
synergies assumed, and the appropriate tax charge for the adjustments.
Remember that in any case where stock is part of the transaction currency, the number of shares will increase.
Add a fourth column which sums the two stand-alone profit and loss accounts along with the transaction
adjustments
From the P&L format, the acquirers standalone position and the pro forma position would
allow for EPS accretion/(dilution) analysis to be performed.
37
Copyright www.educorporatebridge.com
The steps required to complete the pro forma balance sheet are as follows:
1.
Lay out the standalone balance sheet of each company, making sure that each account is properly lined
up (e.g. accounts receivable for one company corresponds to accounts receivable for the other)
2.
Enter the appropriate adjustments from the assumptions made including (if applicable) annual goodwill
amortized, additional interest/expense, synergies assumed, and the appropriate tax charge for the
adjustments.
Remember that in any case where stock is part of the transaction currency, the adjustment to
shareholders equity is a two-step process:
3.
Add a fourth column which sums the two stand-alone balance sheets along with the transaction
adjustments. This column will contain the pro forma balance sheet
38
Copyright www.educorporatebridge.com
Synergies need to be wired into the income statements from the assumptions and included
in the combined sales or EBITDA (depending on the assumption). As synergies might be
difficult to forecast, it has proved helpful to create data tables with varying levels of synergies
and acquisition prices to assess the earnings impact
Annual incremental Depreciation/ amortization needs to be added to both the income statement and the
cash flow statements
The ending balances on amortization schedule must be reflected on the balance sheet
Interest costs on acquisition debt (which may include fees) should be included in the profit
and loss account. The debt should also be included in the balance sheet
Include taxation on your adjustments in the profit and loss account and balance sheet
Merger expenses together with interest costs on these expenses going forward, should be
expensed as incurred.
39
Copyright www.educorporatebridge.com
Capex and asset sales should be wired into the combined cash flow statement
New shareholders equity and PP&E schedules should be created for the combined entity
and connected to the combined balance sheet
If shares are used in the funding mix for the acquisition, this must be reflected in the P&L for
per share metrics and calculations
Dividends must be adjusted to include any increases in shares outstanding and reflected on
the cash flow statement. This adjustment is frequently neglected.
40
Copyright www.educorporatebridge.com
Accretion/(dilution)
Accretion/ (dilution) analysis measures percentage change (of a particular item) pre and post
transaction on a per share basis.
It is used to evaluate the impact of a combination on the shareholders of the acquirer and
target. In turn, it can be used to assess the market reaction and the acceptance of a
transaction by shareholders as it would be made transparent whether the deal adds
shareholder value.
Accretion/ (dilution) analyses can also be applied to non-financial items (e.g. mineral
reserves and production). The usual items that stem from accretion/ (dilution) include:
41
Copyright www.educorporatebridge.com
Accretion/(dilution)
How is it calculated?
Accretion/ (dilution) analysis for EPS enhancement should be included in pro forma profit and
loss summary.
Some models include a calculation which shows post-tax synergies required to make the
transaction earnings neutral.
()
()
42
Copyright www.educorporatebridge.com
Sensitivity analysis
Once a base case is established, a combination analysis should always be tested under
various sensitivity scenarios.
Testing involves examining the incremental effect of various changes in assumptions like
Factoring in fees,
Thought and common sense should be employed in developing reasonable and useful
sensitivity cases. The result of these cases should be attached to the merger model in a clear,
concise format.
43
Copyright www.educorporatebridge.com
Cautionary notes
Much of the process of building a combination model is mechanical and will quickly become
routine. However, keep a few cautionary notes in mind.
Where possible provide support schedules which show the actual mechanics of the combination. This
helps eliminate mistakes and facilitates checking
Be conscious of model structure and format. The easier is it to understand and check the models
mechanics, the less likely it is mistakes will be made
Anticipate running a variety of scenarios (different accounting treatment, acquisition currency, capital
structure, purchase price, etc.) and make the model architecture flexible.
It is often appropriate to calendars the financial statements of the companies if they do not share the
same financial year end
Take care when aggregating the financial statements for two companies. Certain adjustments often cause
error, for example, in relation to share capital and goodwill
44
Copyright www.educorporatebridge.com