Index

Chapter No. Chapter Name Page No.

1 Introduction 1

2 Concepts / Definitions 4

3 Theories of mergers 10

4 Strategies of Mergers & Acquisitions 15

5 Defence Mechanism 23

6 Acquisition & Takeover Regulations - SEBI 25

7 Valuation 34

8 Legal Issues Relating to Mergers 51

9 De-merger & Reverse merger 57

10 Post Merger Scenario 60

11 Post Merger Integration 64

Chapter One
 Introduction

Mergers, acquisitions and restructuring have become a major force in the financial and
economic environment all over the world. Essentially an American phenomenon till the
middle of 1970s, they have become a dominant global business theme at present. On Indian
scene too corporate are seriously making at mergers, acquisitions which has become order of
the day.

Mergers and acquisitions (M&A) and corporate restructuring are a big part of the corporate
finance world. Every day, Wall Street investment bankers arrange M&A transactions, which
bring separate companies together to form larger ones. When they're not creating big
companies from smaller ones, corporate finance deals do the reverse and break up companies
through spin-offs, carve-outs or tracking stocks.

Not surprisingly, these actions often make the news. Deals can be worth hundreds of
millions, or even billions, of dollars. They can dictate the fortunes of the companies involved
for years to come. For a CEO, leading an M&A can represent the highlight of a whole career.
And it is no wonder we hear about so many of these transactions; they happen all the time.
Next time you flip open the newspaper’s business section, odds are good that at least one
headline will announce some kind of M&A transaction.

Sure, M&A deals grab headlines, but what does this all mean to investors, it discusses the
forces that drive companies to buy or merge with others, or to split-off or sell parts of their
own businesses. Once you know the different ways in which these deals are executed, you'll
have a better idea of whether you should cheer or weep when a company you own buys
another company - or is bought by one. You will also be aware of the tax consequences for
companies and for investors.

If one considers available statistics, one finds that M & A activity is taking place with a very
rapid pace:

 Acquisitions

Years No. of Acquisitions Bids Amount (Rs. Crore)

2005 – 06 868 102904
2004 – 05 798 60284
2003 – 04 833 35319
2002 – 03 841 32696
2001 – 02 1048 35086
2000 – 01 1174 23113

 Mergers

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 Years No. of Merger Deals
2005 – 06 368
2004 – 05 272
2003 – 04 284
2002 – 03 332
2001 – 02 319
2000 – 01 317

 Industry-wise Trend of Number & Value of Acquisitions:

Number of Value of Acquisitions

Sector
Acquisitions (Rs. Crore)
Manufacturing 436 45106
Food & Beverages 48 2528
Textiles 57 1946
Chemicals 115 21698
Non Metallic Mineral Products 41 6331
Metals & Metal Products 35 2091
Machinery 69 4309
Transport Equipments 39 5039
Miscellaneous Manufacturing 25 687
Diversified 7 475
Mining 8 914
Coal & Lignite 2 58
Crude Oil & Natural Gas 3 844
Minerals 3 12
Electricity 9 3751
Electricity Generation 8 3751
Electricity Distribution 1 -
Services 356 51882
Financial Services 126 15884
Other Services 230 35998
Hotels & Tourism 26 1859
Recreational Services 31 1993
Health Services 8 912
Trading 29 1086
Transport Services 12 3303
Communication Services 25 13677
Misc. Services 21 3513
Information Technology 78 9657
Construction 52 5212

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 Real Estate 41 4505
Construction & Allied Activities 11 706
Total 938 110240

 Industry-wise Trend of Number of Mergers:

Sector Number of Mergers

Manufacturing 136
Food & Beverages 23
Textiles 24
Chemicals 39
Non Metallic Mineral Products 9
Metals & Metal Products 7
Machinery 20
Transport Equipments 2
Miscellaneous Manufacturing 12
Diversified -
Mining 2
Coal & Lignite -
Crude Oil & Natural Gas -
Minerals 2
Electricity 2
Electricity Generation 2
Electricity Distribution -
Services 159
Financial Services 90
Other Services 69
Hotels & Tourism 3
Recreational Services 6
Health Services 2
Trading 20
Transport Services 2
Communication Services 4
Misc. Services 19
Information Technology 13
Construction 13
Real Estate 7
Construction & Allied Activities 6
Total 414

* Source for Statistical Data: CMIE Chapter Two

CONCEPTS / DEFINITIONS:

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Important terms used in the world of mergers & acquisition, & their brief explanation:

1) Merger:
Merger is defined as the combination of two or more companies into a single company where
one survives and the other loses its corporate existence. The survivor acquires the assets as
well as liabilities of the merged company or companies.

2) Amalgamation:
Halsbury’s Laws of England describe amalgamation as a blending of two or more existing
undertakings onto one undertaking, the shareholders of each blending company becoming
substantially the share holders in the company which is to carry on the blended undertaking.

Section 2 (a) of Income Tax Act defines: Amalgamation in relation to companies means the
merger of two or more companies to form one company in such a manner that:

1. All the properties of the amalgamating company or companies just before the
amalgamated company by virtue of amalgamation become the properties of
amalgamation.
2. All the liabilities of the amalgamating company or companies just before the
amalgamation become the liabilities of the amalgamation; become the liabilities of
the amalgamated company by virtue of amalgamation.
3. Shareholders holding not less than three-fourth in value of shares in the amalgamating
company or companies becomes the shareholders of the amalgamated company by
virtue of amalgamation.
The term amalgamation and merger are synonymous / Interchangeable

3) Consolidation:
Technically speaking consolidation is the fusion of two existing companies into a new
company in which both the existing companies extinguish. The small difference between
consolidation and merger is that in merger one of the two or more merging companies retains
its identity while in consolidation all the consolidating companies extinguish and an entirely
new company is born.

4) Acquisitions / Takeovers:
This refers to purchase of majority stake (controlling interest) in the share capital of an
existing company by another company. It may be noted that in the case of takeover although
there is change in management, both the companies retain their separate legal identity.

Terms Takeover & Acquisition are used interchangeably.

5) Leveraged Buyouts:
It means any takeover which is routed through a high degree of borrowings. In simple words
a takeover with the help of debt.

6) Management Buyouts:
It refers to the purchase of the corporation part or whole of shareholding of the controlling /
dominant group of shareholders by the existing mangers of the company.
7) Sell Off :

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 General Term for divestiture of part or whole of the firm by any one or number of means:
i.e. sale, spin off, split up etc.

8) Spin Off:
A transaction in which a company distributes all the shares it owns in a subsidiary to its own
shareholders on pro-rata basis & then creates a new company with the same proportional
shareholding pattern as in the parent company.

9) Split Off :
A transaction in which some, but not all, shareholders of the parent company receive shares
in a subsidiary, for relinquishing their parent company shares.

10) Split Up :
A transaction in which a company spins off, all of its subsidiaries to it shareholders and
ceases to exist.

11) Equity Carve Out :

A transaction in which a parent company offers some common stock of one of its
subsidiaries to the general public, so as to bring in a cash infusion to the parent company
without losing the control.

TYPES OF MERGERS & ACQUISITIONS:

Mergers & Acquisition can be classified into three categories:

a) On the basis of movement in the industries:

– Horizontal
– Vertical
– Forward integration
– Backward integration
– Conglomerate

b) On the basis of method or approach:

– Leveraged buyouts
– Management buyouts
– Takeover by workers

c) On the basis of response / relation:

– Friendly Takeovers
– Hostile Takeovers

Explanation of the various types of mergers and acquisitions:

1. Horizontal Mergers:

Horizontal merger involves merger of two firms operating and competing in the same
line of business activity. It is performed with a view to form a larger firm, which may

6
 have economies of scale in production by eliminating duplication of competitions,
increase in market segments and exercise of better control over the market. It also
helps firms in industries like pharmaceuticals, automobiles where huge amount is
spent on R&D to achieve a critical mass and reduce unit development costs.

Horizontal merger tend to be regulated by the Govt. in view of their potential for
creating monopoly power and negative effect on competition.

Example: India cements acquiring Raasi Cement.

2. Vertical Mergers :

Vertical Mergers take place between two or more firms engaged in different stages of
production. The main reason for vertical merger is to ensure ready take off of the
materials, gain control over scarce raw materials, gain control over product
specifications, increase in profitability by eliminating the margins of the previous
supplier/ distributor and in some cases to avoid sales tax.

Example: Tea Estate Ltd merging with Brooke Bond Ltd.

3. Conglomerate Mergers:

Conglomerate merger refers to the merger of two or more firms engaged in unrelated
line of business activity.

Two important characteristics of conglomerate mergers are:

i. A conglomerate firm controls a range of activities in various industries that
require different skills in the specific managerial functions of research,
applied engineering, production and marketing.
ii. The diversification is achieved mainly by external acquisitions and mergers
and not by internal development.

Among conglomerate mergers three types may be distinguished:

i. A product extension merger broadens the product line of firm.
ii. A geographic market extension merger involves firms whose operations are
conducted in non overlapping geographic areas.
iii. Other conglomerate mergers involving unrelated business and do not qualify
for product extension or geographic extension.

Example: GNFC acquiring Gujarat Scooters.

Conglomerate mergers can be further classified as Financial Conglomerates &

Managerial Conglomerates:

a) Financial Conglomerates:

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 Financial Conglomerates provide a flow of funds to each segment of the operations,
exercise controls and are the ultimate risk takers. In theory, financial conglomerates
undertake strategic planning but do not participate in operating decisions.

Financial conglomerates take care of five distinct economic functions:

1. It improves risk / return ratios through diversifications
2. It avoids “Gamblers Ruin”. Financial Conglomerates maintain economic
viability with long term value. Without this form of risk reduction, or bankruptcy
avoidance, the assets of the operating entity might be shifted to less productive
areas.
3. It establishes system of financial planning and control which improves the
quality of general and functional managerial performance.
4. If the management does not improve performance, the management is changed.
5. Better resource allocation. If management is competent but product market
potentials are inadequate, executives of financial conglomerate will seek to shift
resources from the unfavorable areas to areas more attractive from point of view
of growth and profitability.

b) Managerial Conglomerates:

Managerial conglomerates not only assume financial responsibility but also play a
role in Operating decisions and provide staff expertise and staff service to the
operating entities. By providing managerial counsel and interactions on decisions, the
managerial conglomerates increase the potential for improving performance. When
any two firms of unequal management competence are combined the performance of
combined firm will benefit from the impact of the superior management and total
performance of combined firm will be greater that the sum of individual parts. This
defines synergy in most general form.

Concentric Companies

The difference between managerial conglomerates and the concentric company is

based on the distinction between the general and specific management functions.
If the activities of the segments brought together are so correlated that there is carry
over of specific management functions (research, manufacturing, finance, marketing,
personnel and so on) or complementarily in relative strengths among these specific
management functions, the merger should be called concentric rather than
conglomerate.

The concentric merger is also called product extension merger. In such a merger, in
addition to transfer of general management skills, there is transfer of specific
management skills, as in production, research, marketing etc. which have been neither
used in different line of business. A concentric merger brings all the advantages of
conglomeration without the side effects i.e, with concentric merger, it is possible to
reduce the risk without venturing into areas that the management is not competent in.
4. Consolidation Mergers:

Consolidation merger involves a merger of a subsidiary company with parent company.

The reasons behind such mergers are to stabilize cash flows and to make funds
available for the subsidiary. In consolidation mergers, economic gains are not readily

8
 apparent as merging firms are under the same management. Still, Flow of funds
between parent and the subsidiary is obstructed by other consideration of laws such as
taxation laws, Companies Act etc. Therefore, consolidation can make it easier for to
infuse funds for revival of subsidiaries.

MERGER MOTIVES:
The merger motives are as follows:
(1) Growth Advantage / Combination Benefits:
The companies would always like to grow and best way to grow without much loss of
time and resources is to inorganically by acquisition and mergers.

E.g.: Merger of
• SCICI with ICICI
• ITC Classic with ICICI
Acquisition of
• Raasi cement by India cement
• Dharani Cement and Digvijay cement by Grasim
• Modi cement by Gujarat Ambuja.

(2) Diversification:
The companies could diversify into different product lines by acquiring companies
with diverse products. The purpose is to diversify business risk by avoiding to put all
eggs into one basket.

E.g.: All Multi-product companies

(3) Synergy:
When the companies combine their operations and realize results greater in value than
mere additions of their assets, the synergy is said to have been resulted.

Combined efforts produce better results on account of

i) Rationalization of operating assets of merged companies.
ii) Sharing of sales outlets / distribution channels.
iii) Cost reduction / savings.

E.g.: Merger of Ranabaxy and Crossland Laboratories.

(4) Market Dominance / Market Share/ Beat Competition:

The predominant market share or market dominance has always driven the executives
to look for acquiring competitive companies and create a huge market empire.

E.g.: Acquisition of Tomco by Hindustan Lever

Computer Associates International - Acquired around twenty software
companies.
Consolidation in cement industry
Nicholas Piramal Ltd. has merged into itself.
(5) Technological Considerations:
It refers to enhancing production capacities to derive economies of scale.

E.g.: Acquisition of Corus by Tata.

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(6) Asset Tripping:
When the companies are acquired for the hidden assets which are owned and these
assets can be separately developed or even sold off for profit.

E.g.: Textiles companies being taken over for the surplus land which could be
developed for real estate / malls

(7) Taxation Benefits / Revival Of Sick Units:

Section 72 A provides for revival of sick units by allowing accumulated losses of the
sick unit to be absorbed by the healthy units subject to compliances to the conditions
of the provisions.

(8) Acquiring Platform:

When a company would like to expand beyond geographical limits and acquire
platform in the new place the best way would be to acquire the companies.

E.g.: Acquisition of Parle by Coke.

Chapter Three

Theories of Mergers

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Theories provide an explanation to any phenomenon, pattern and provide basis for further
action plan. The phenomenon of merger and acquisitions has been explained by different
theories as under:

I. Efficiency Theories
a) Differential Managerial Efficiency
b) Inefficient Management
c) Operating Synergy
d) Pure diversification
e) Strategic Realignment to changing environments
f) Under Valuation
II. Information and Signaling
III. Agency Problems and managerialism
IV. Free Cash flow hypothesis
V. Market Power
VI. Taxes
VII. Redistribution

The explanation of the various theories is as follows:

I. Efficiency Theories
a) Differential Efficiency:
If the management of firm A is more efficient than the management of firm B and if after
firm A acquires firm B, the efficiency of firm B is brought up to the level of efficiency of
firm A, efficiency is increased by merger.

• Features:
- There would be social gain as well as private gain.
- This may also be called managerial synergy hypothesis.

• Limitations:
- If carried to its logical extreme, it would result in only one firm in the economy, the
firm with greatest managerial efficiency.
- Over-optimization on the part of efficient firm about its impact on acquired firm may
result in excess payment of consideration or failure to improve its performance.
- Inefficient / under performing firms could improve performance by employing
additional managerial input through direct employment / contracting.

b) Inefficient Management:
Inefficient Management refers to non performance up to its potential level. It may be
managed by another group more efficiently.

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 • Features:
- Inefficient Management represents management which is inept in absolute
sense.
- Differential management theory is more likely to be basis for horizontal
merger; inefficient management theory could be basis for mergers between firms of
unrelated business.

• Limitations:
- Difficult to differentiate differential management theory from inefficient
theory.
- The theory suggests replacement of inefficient management. However
empirical evidence does not support this.
- The theory also suggests that acquired firms are unable to replace their own
managers and thus it is necessary to invoke costly merger to replace inefficient
managers- This is not convincing.

c) Operating Synergy:
Operating synergy or operating economies may be achieved in horizontal, vertical and
even conglomerate mergers.

• Features:
- Theory is based on the assumption that economies of scale do exist in this
industry and prior to merger, firms are operating at the levels of activity that fall short
of achieving the potential for economies of scale.
- Economies of scale arise because of indivisibilities such as people, equipment
overhead which provide increasing returns if spread over a large number of units of
output.

d) Pure Diversification:
Diversification of the firm can provide the managers and employees with job security and
opportunity for promotion and other things being equal, results in lower costs. Even for
owner manager diversification is valuable as risk premium for undiversified firm is
higher.

Diversification has value for many reasons:

- Demand for diversification by managers, other employees
- Preservation of organizational and reputation capital
- Financial and tax advantages
- Diversification helps preserving reputational capital of the firm, which will be
lost if firm is liquidated.

Diversification can be achieved through internal growth as well as mergers. However

mergers may be preferred in certain circumstances:
- Mergers can provide quick diversification.
- Firm may lack internal growth opportunity for lack of requisite resources or
due to potential excess capacity in industry.

e) Strategic Realignment to Changing Environment:

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 Strategic planning is concerned with firm's environment and constituencies, not just
operating decisions. The speed of adjustment through merger would be quicker than
internal development.

• Features:
- Strategic planning approach to mergers implies either the possibilities of
economies of scale or tapping an underused capacity in the firms present managerial
capabilities.
- By external diversification the firm acquires management skills for
augmentation of its present capabilities.
- A competitive market for acquisitions implies that the net present value from
merger and acquisition investment is likely to be small. Nonetheless if synergy can be
used as a base for still additional investments with positive net present values, the
strategy may succeed.

f) Under Valuation:
Some studies have attributed merger motives to under valuation of target companies.
- One cause of under valuation may be that management is not operating the
company up to its potential (aspect of inefficient management theory.)
- Second possibility is that acquirer has an inside information. Hence, its bidder
possesses information which general market does not have, they may place higher
value on the shares than currently prevailing in the market.
- Another aspect of under valuation theory is the difference between the market
value of assets and their replacement costs. Hence entry into new product market
areas could be accomplished on a bargain basis.

II. Information and Signaling:

Shares of the target company in a tender offer experiences upward revaluation even if
offer turns out to be unsuccessful. New information generated as a result of tender offer
and the revaluation is permanent.

Two forms of information:

i) The tender offer disseminates the information that the target shares are undervalued
and offer prompts the market to revalue the shares.
ii) Offer inspires the target firm management to implement a more efficient business
strategy on its own.

Signaling may be involved in number of ways:

- Tender offer gives a signal to the market that hither to unrecognized extra
values are possessed by the firm or that
- Future cash flow streams are likely to rise.
- When a bidder firm uses common stock on buying another firm, it is taken as
a signal that common stock of bidder firm is overvalued.
- When buyer firm repurchases their shares, the market may take this as signal
that the management has information that its shares are undervalued and favorable
new opportunities will be achieved.

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III. Agency problems and Managerialism :

Agency problem arises when a manager owns a fraction of ownership shares of the firm.
This partial ownership may cause managers to work less vigorously than other wise and /
or consume more perquisites, (luxurious offices, company cars, membership of clubs)
because majority owners bear most of the cost.

Agency costs include:

i) Cost of structuring a set of contracts
ii) Cost of monitoring and controlling the behavior of agents by principals.
iii) Cost of bonding to guarantee that agents will make optimal decisions or principles
will be compensated for consequences of sub-optimal decisions.
iv) Residual loss: i.e. welfare loss experienced, by the principals arising from the
divergence between agent’s decisions and decisions to maximize principal’s
warfare. This residual loss can arise because the cost of full enforcement of
contracts exceeds the benefits.

Takeover as solution to Agency Problems:

o Agency problems can be controlled by organizational or market mechanism:

o A number of compensation arrangements and market for managers may
mitigate agency problems.
o Stock market gives rise to external monitoring device, because stock prices
summaries the implications of decisions made by managers. Low stock prices exert
pressure on managers to change their behavior and to stay in line with interest of
shareholders.
o When these mechanisms are not sufficient, market for takeover provides an
external control device of last resort.
o A takeover through a tender offer or proxy fight enables outside managers to
gain control of decision process of Target Company, while circumventing the
existing managers and Board of Directors.

Managerialism

In contrast to the view that mergers occur to control agency problem, some observers
consider merger as manifestation of agency problems rather than the solution.
Mueller emphasizes that managers are motivated to increase the size of the firm as
compensation to manager is function of the size of the firm.
But empirical evidence shows that compensation is correlated with profit rate and not
with level of sales.

IV. Free Cash flow hypothesis

Jenson argues that pay out of free cash flow can play an important role in dealing with
conflict between managers and shareholders.
Payout of free cash flow reduces the amount under control of managers and reduces
their power. Further they are subject to monitoring in capital market when they seek to
finance additional investment with new capital.
He states that such a free cash flow must be paid out to shareholders if firm is to be
efficient and to maximize share price.

14
 Layout of free cash flow reduces the amount under control of managers and reduces
their power. Further they are subject to monitoring in capital market when they seek to
finance additional investment with new capital.
Managers arrange cash flows also by issuing debts / leveraging.
In leveraged buyouts, increased debt increases risk of bankruptcy cost in addition and
agency costs.
Optimum debt / Equity Ratio will be where the marginal cost of debt equals marginal
benefit of debt.

Hubris Hypothesis
Roll hypothesis - that managers commit errors of over-optimism in evaluating merger
opportunities due to excessive pride, animal spirit or hubris.

In a takeover, bidding firm identifies potential target firm and values its assets.
When valuation turns out to be below market price of the stock, no offer is made.
Only when valuation of stock exceeds its Bid is made.

Current market price:

If there are no synergies or other takeover gains the mean valuation will be current
market price. Offers are made only when valuation is too high. Takeover premium is
random error, a mistake made by the error.

V. Market Power

Mergers increase a firm’s market share. It is argued that larger volume of operations
through Mergers and Acquisitions result in economies of scale. But it is not clear
whether this price required by the selling firm will really make acquisition route more
economical method of expanding a firm's capacity either horizontally or vertically.

An objection often raised against permitting a firm to increase its market share by
merger is that it will result into "undue concentration" in the industry.

Public policy of USA holds that when four or fewer firms amount for 40% or more of
the sales in given market or line of business, an undesirable market structure or undue
concentration exists.

VI. Tax consideration

• Section 72 A of Income Tax

• Revival of Sick Units under SICA
• Reverse mergers.
(Detail explanation pertaining to above is available in chapter)

VII. Value increase by Redistribution

Value increases under merger on account of redistribution among the stake holders of the
firm. Shifts are from the Bond holders to stock holders and from labor to stock holders and /
or consumers.

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 Chapter Four

Strategies of Mergers & Acquisitions

The various strategies are as follows:

I. Mergers and Acquisitions as Managerial Strategy.

Forms of Business Restructuring

Expansion
Corporate Control

Mergers Acquisitions Joint

Venture Premium standstill Anti takeover Proxy
Buy Backs agreements Amendments contests

Spin offs Divestitures Equity Curve outs

Changes in ownership
structure

Split Split
Offs Ups
Exchange Share Going Leveraged
Offers repurchases Private Buyouts

II. Mergers and Acquisitions as Management Strategy:

The different views are as follows:

 Strategy as concept
 Strategy as Process
 Concerned with most important decisions of an
enterprise.
 Strategic planning process
- set of formal procedure
- Informally in the mind managers
 Individual strategies, plans, Policies or procedures are
utilized.
 Strategic planning as behavior A way of thinking
- Requiring diverse inputs from all segments
- Everyone must be involved
 Responsibility resides with Top executive.

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 The process of strategic planning:

1) Monitoring environments:
A key to all approaches to strategic planning is continuous monitoring of the external
environments. The environments should encompass both domestic and international
dimensions and include analysis of economic, technological, political, social and legal
factors.

Different organization may give different emphasis and weights to each of the categories.

2) Stakeholders:
Strategic planning process to take into account the diverse stakeholders of organization,
which have interest in the organization i.e., customers, stockholders, creditors,
employees, Government, Communities, Media, Political group, Educational institutions,
financial community and international entity.

3) Essential elements in strategic planning processes:

i. Assessment of changes in the environment.
ii. Evaluation of company capabilities and limitations.
iii. Assessment of expectations of stakeholders.
iv. Analysis of company, competitors, industry, domestic economy, and international
economies.
v. Formulation of missions, goals and policies for master strategy.
vi. Development of sensitivity to critical external environmental changes.
vii. Formulation of Long-range strategy programmes.
viii. Formulation of internal organization performance measurements.
ix. Formulation of mid-range and short run plans.
x. Organization, Funding and other method to implement all preceding elements.
xi. Information flow and feedback system
xii. Review and evaluation process.

4) Organization cultures:
How organization carries out the strategic thinking and planning processes will vary with
it cultures.

i.Strong top leadership v/s Team appraisals.

ii.Management by formal paperwork v/s Management by wandering around.
iii. Individual decisions v/s Group decisions.
iv. Rapid evaluation based on performance v/s Long term relationship based on loyalty.
v. Rapid feed back for change v/s Formal bureaucratic rules and procedures.
vi. Risk taking encouraged v/s one mistake and you are out.
vii. Narrow responsibility v/s everyone in this is a salesman cost controller, product
quality manpower or so on.
viii. Learn from customer’s v/s we know what is best for customers.

5) Alternative strategy methodologies:

i. SWOT or WOTS Up: Inventory and analysis of organization strength, weaknesses,

environmental opportunities, and threats.

17
 ii.
Gap Analysis: Assessment of goals v/s forecasts or projections.
iii.
Top down / Bottom up: Company forecasts v/s aggregation of segments.
iv.
Computer models: Opportunity for detail and complexity.
v.
Competitive Analysis: Assess customers, suppliers, new entrants, products and
product substitutability.
vi. Synergy : Look for complementarily
vii. Logical incremental: Well supported moves from current bases.
viii. Muddling through: Incremental changes selected from small no. of policy
alternatives.
ix. Comparative histories: Learn from experience of others.
x. Delphi Technique: Iterated opinion reactions.
xi. Discussion group technique: Simulating ideas by unstructured discussions aimed at
consensus.
xii. Adaptive Processes: Periodic reassessment of environmental opportunity and
organization capability adjustment required.
xiii. Environmental scanning: Continuous analysis of relevant environments.
xiv. Intuition: Insights of brilliant managers.
xv. Entrepreneurship: Creative leadership.
xvi. Discontinuities: Crafting strategy from recognition of trend shifts.
xvii. Brain storming: Free form repeated exchange of ideas.
xviii. Game theory: Logical assessment of competitor’s actions and reactions.
xix. Game playing: Assign roles and simulate scenarios.

6) Alternative Analytical framework:

i. Product Life cycles: Introduction, Growth, maturity, and decline stages with changing
opportunities and threats.
ii. Learning curve: Costs decline with cumulative volume experience resulting in first
mover competitive advantages.
iii. Competitive Analysis: Industry structure, rivals reactions, supplies and customer
relations, product positioning.
iv. Cost leadership : Low cost advantages
v. Product differentiation: Develop product configuration that achieve customer
preference.
vi. Value chain Analysis: Controlled cost outlays to add product characteristics valued
by customers.
vii. Niche opportunities: Specialize to needs or interest of customer groups.
viii. Product breadth: Carry over of organizational capabilities.
ix. Correlation's with profitability: Statistical studies of factors associated with high
profitability measures.
x. Market share: High market share associated with competitive superiority.
xi. Product quality: Customer allegiance and price differentials for higher quality.
xii. Technological leadership: Keep at frontiers of knowledge.
xiii. Relatedness matrix: Unfamiliar markets and products involve greatest risk.
xiv. Focus matrix : Narrow v/s Broad
xv. Growth / share matrix: Aim for high market share in high growth markets.
xvi. Attractiveness matrix : aim to be strong in attractive industries
xvii. Global matrix: Aim for competitive strength in attractive countries.

7) Approaches to formulating Mergers and Acquisitions strategy:

i. Boston Consulting Group

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 ii. The Porter Approach
iii. Adaptive Processes

i. Boston Consulting Group:

The three important concepts of BCG are as follows:
• Experience curve
• Product life cycle
• Portfolio balance

o Experience curve:
It represents a volume-cost relationship. It is argued that as the cumulative
historical volume of output increases, unit cost will fall at a geometric rate. This
will result from specialization, standardization, learning and scale effects.
The firm with target cumulative output will have lower costs, suggesting a
strategy of early entry and price policy to develop volume.

o Product life cycle:

Every product or a line of business proceeds through four places:

Development
Growth
Maturity
And decline

During first two stages, sales and growth is rapid and entry is easy. As individual
firms gain experience and as growth slows in last 2 stages, entry becomes
difficult, because of cost advantages of incumbents.

In declining stage of product line, (as other substitutes emerge) sales and prices
decline, firms which have not achieved a favorable position on the experience
curve become unprofitable and either merge or exit from the Industry.

o Portfolio Approach:
Rapid growth may require substantial investments. As requirements for growth
diminish, profits may generate more funds than required for investments.
Portfolio balances seeks to combine

 Attractive investment segments ( stars)

 Cash generating segments (cash cows)
 Eliminating segments with unattractive prospects (Dogs)

Overall, total cash inflows will balance and corporate investments.

ii. The Porter Approach:

Michael Porter suggests the following:
• Select an attractive industry.
• Develop competitive advantage through cost leadership and product
differentiation.
• Develop attractive value chain.

19
 o Attractive Industry in which:
 Entry barriers are high.
 Suppliers and buyers have only modest bargaining power.
 Substitute products or services are few.
 Rivalry among 'competitors' is stable.

o Unattractive Industry will have:

 Structural flows
 including plethora of substitute materials
 Powerful and price sensitive buyers.
 Excessive rivalry caused by high fixed costs and large group of
competitors, many of whom are state supported.
 E.g.: Steel Industry.

o Competitive Advantage:
It may be based on cost leadership, product differentiation. Cost advantage is
achieved by consideration of wide range of checklist factors including BCG's learning
curve theory.

o Value chain:
A matrix that relates the support activities of:
 Infrastructure
 Human Resource Management
 Technology development
 Procurement
 Operations
 Marketing / Sales / Service

Aim is to minimize outlays in adding characteristics valued by customers.

iii. Adaptive Processes:

Adaptive processes orientation involves marketing resources to investment
opportunities under environmental uncertainty compounded with uncertain
competitor’s actions and reactions. It involves ways of thinking which assess
competitor’s actions and reactions in relation to changing environments.

8) Factors favoring external growth and diversification through Mergers and

Acquisitions:
i. Some goals and objectives may be achieved more speedily through an external
acquisition.
ii. The cost of Building an organization internally may exceed cost of an acquisition.
iii. There may be fewer risks, lower costs, or shorter time requirements involved in
achieving an economically feasible market share by the external route.

20
 iv. The firm may not be utilizing their assets or arrangement as effectively as they could be
utilized by the acquiring firm.
v. The firm may be able to use securities in obtaining other companies, where as it might
not be able to finance the acquisition of equivalent assets and capabilities internally.
vi. There may be tax advantages.
vii. There may be opportunities to complement capabilities of other firms.

9) Gains and Pains of Merger and Acquisition:

Gains Pains

Financial Returns/Profitability i. Expenses / Drain on Profitability

Aligned Org Structure.
iii. New approaches to conducting
work.
Motivated and capable talent.
Desired culture.
ii. Time and resource required to
manager / transition.
iii. Reduced work productivity and
quality.
iv. Unintended consequences for
employee’s attitudes and behavior.
v. Culture clash.

Cost Savings. vi. Customer concerns.

10) Planning for Merger and Acquisition:

i. Search for acquisition of Target Company based on objectives of the acquirer company.
ii. Services of Intermediaries
a) Finding a Target company
a) Consultants b) Negotiation
b) Merchant bankers c) Compliance of legal
formalities
c) Financial Institutions d) Completion of Financial arrangement
e) Closing the deals.

iii. Primary investigation about Target Company.

a) Industry Analysis Competition

Growth Rate / Future projections
Barriers to entry / Exit
Mergers and acquisitions in industry and results

b) Financial Analysis Balance sheet and Profit and loss for

past years
Budgets and forecasts
Financial ratios - Return on Assets
- Return on Net worth
- GP / NP
- D/ E Ratio
- Expense Ratio

21
 Replacement cost data
Valuation of Assets / Liabilities

c) Management Analysis Assessment of Senior

Management
Business Experience
Union Contract / Strike History
Labour Relations / Agreements
Personnel Schemes
Profile of permanent employees
d) Marketing Analysis Data on Past Sales
Customer profile
Major sales agreements
Trends
Distribution channels
Product Profile
Development / Disclosure

e) Manufacturing Location
Technology
Manufacturing process
Quality
R&D

iv. Other Information

- Inventory valuation, obsolescence, over valuation.
- Litigation
- Doubtful debts
- Unrealized / Unrealizable Assets / Investments
- Tax status / Assessments / Outstanding dues

v. Economic Analysis
- Business Cycles
- Public Interest
- Government Prices / Incentives
- Condition of securities market

vi. Comparison of Alternative Target companies and Arrival of decision as regards target
company.
vii. Strategy for takeover - method to be employed.
- Friendly take over through negotiations
- Hostile

viii. Valuation of Assets and arriving at Purchase consideration.

ix. Mode of Payment
- Cash
- Share Exchange Ratio

x. Legal formalities
- Takeover code
- Company law

22
 - Income tax / SICA / IDR / MRTP

xi. Post Merger Integration.

Additional Information
 When are Mergers and Acquisitions Successful?
 If one plus one equals three - Mergers and acquisitions is successful.

 Do Mergers and Acquisitions always succeed?

 International studies suggest: 75% of all mergers fail only 25% succeed.

Some findings of International Studies:

(1) About 15% of Mergers and Acquisitions in USA achieve their financial objectives as
measured by share value, return on Investment and Post combination profitability.
[Course in Mergers and Acquisitions, American Management Association,
1997]

(2) Up to 75% of European Mergers end in failure.

[Harper J and Cormeraic S. Journal of European Inds. Training 1995]

(3) Separate studies by McKinsey & Co. and Coopers & Lybrand report that about 70%
alliances fail or fall short of expectations.

23
 Chapter Five

Defence Mechanism

Defene mechanisms are the tools used by a company to prevent its takeover. In order to ward
off take over bid, the companies may adopt:

I. Preventive Measures
II. Defence strategies in the wake of take over bid.

These defensive measures are elaborated below:

I. Advance / Preventive Measures:

a) Joint holding / Agreements between major shareholders
b) Interlocking / Cross holding of shares.
c) Issue of block of shares to friends and Associates.
d) Defensive merger with own group company.
e) Non-voting shares / Preference shares
f) Convertible debentures
g) Maintaining part of capital uncalled for making emergency requirements.
h) Long term service agreements.

II. Defence in the wake of takeover bid :

a) Commercial Strategies
i) Dissemination of favourable information to keep shareholders abreast of
latest developments.
- Market coverage
- Product demand
- Industries outlook and resultant profit.

ii) Step up dividend and update share price

iii) Revaluation of Assets
iv) Capital structure Re-organization
v) Unsuitability of offertory to be highlighted while communicating with
shareholders.

24
b) Tactical, defense strategies
i) Friendly purchase of shares
ii) Emotional attachment loyalty / participation
iii) Recourse to legal action
iv) Operation white Knight.
White Knight enters the fray when the target company is raided by
hostile suitor. White Knight offers bid to target company – higher than the
offer of the predator that may not remain interested in the bid.

v) Disposing of Golden jewels :

Precious assets of the company are called cream jewels which attract
the raider. Hence as a defence strategy, company sells these assets at its own
initiative leaving rest of the company intact. Raider may not remain
interested thereafter.

vi) Pac-Man Strategy:

In this strategy, the target company attempts to take over the
raider. This happens when Target Company is higher than the predator.

vii) Compensation Packages:

Golden parachutes or First class passenger strategy termination
package for senior executives is used as protection for Directors.

viii) Shark Repellants:

Companies change and amend their bye laws to make it less
attractive for corporate raider.

ix) Ancillary Poison Pills:

Issue of convertible debentures - which when converted dilutes
holding percentage of raider and makes it less attractive.

25
 Chapter Six

Acquisition and Takeover Regulations

(SEBI Regulations)

Securities Exchange Board of India (SEBI) is a market regulator and has issued takeover
guidelines popularly called takeover code as under:

I. Exempted Categories:
a) Allotment in pursuance of an application made in public issue.
b) Allotment in pursuance of Rights Issue
c) Preferential Allotment made in pursuance of Sec. 81 (1A)
d) Allotment in pursuance of an underwriting agreement.
e) Intense transfer of shares amongst
− Group companies
− Relatives
− Promoters / Indian promoters and foreign promoters who are shareholders

f) Acquisition of shares in ordinary course of business by

− Registered stock broker of stock exchange on behalf of clients
− Registered market maker of a Stock Exchange
− Public financial institution on their own account
− Banks / Financial Institutions as pledge

g) Acquisition of shares by way of transmission or succession or inheritance.

h) Acquisition of shares by government companies
i) Transfer of shares from state level financial institutions including subsidiaries pursuant to
agreement between such FIS and Promoters.
j) Transfer of shares venture capital funds to promoters.
k) Under BIFR scheme
l) Acquisition of shares of companies not listed other cases as may be exempted by SEBI.
m) In respect of exempted cases for acquisition exceeding 15%
− Application to be made to SEBI within 21 days
− Giving details / reasons seeking exemption
− Payment of fee to SEBI Rs. 10,000/-
n) In respect of notification for information to public, it should be made in case of acquisition
exceeding 5% of voting rights.

26
II. Disclosure required to be made in respect of acquisition of shares / Voting rights.

a) Existing shareholders holding more than 5% of shareholding / voting rights

− Disclosure to be made to the company within 2 months from the date of SEBI
Regulations.

b) Acquisition of 5% and 10% of voting rights

− Disclosure to be made to company within 4 working days of
− Receipt of intimation of allotment of shares
− Acquisition of shares

c) Company to disclose to all stock exchanges where shares are listed

− Within 7 days of receipt of information.

d) Continual disclosure by those who held more than 15%

− Within 21 days from the close of financial year

e) Company to make annual disclosure

− Within 30 days from the close of financial year

III. Substantial Acquisition / Public Announcement

a) Acquisition of 15% or more shares / voting rights

− Public announcement

b) Consolidation of holding from 15% to 75%

− In any year acquisition should not be more than 10% unless announcement is
made.
c) Conditions precedent to public announcement
− Appointment of Merchant Banker
− Timing of Announcement, within 4 working days of entering into agreement
for acquisition of shares
− Publications of announcement : In all editions of the English daily, one Hindi
daily, one Regional language daily where registered office of company is
located.
− Copy to be submitted to: SEBI, Stock Exchange and Target Company

IV. Contents of Public Announcement Offer

a) Target company
− Existing paid up capital
− No. of fully paid shares
− No. of partly paid shares

b) Total number of percentage shares of the target company to be acquired from the
public by the acquirer subject to minimum of 20% of voting capital of the company.

c) Minimum offer price

27
 d) Mode of payment of consideration.
e) Identity of acquirer / acquirers
f) Existing holding
g) Agreement to acquire shares
− Date of Agreement
− Name of the seller
− Price of which shares are to be acquired.
− No. of percentage of shares to be acquired.

h) Price paid by acquirer and persons acting in concert with him, during last 12 months.
− The highest price
− The average price

i) Object and purpose of acquisition and future plans.

j) Date of opening of offer / closing of offer
k) Date by which purchase consideration would be paid
l) Disclosure to the effect that firm financial arrangement required to implement has
been made.
m) Other statutory approvals if any;
n) Approval of Banks / Institutions
o) Minimum level of acceptances from the shareholders
p) Such other information as is essential for the shareholders to make informal decision.
− Submission of letter of offer to SEBI within 14 days from the date of public
announcement made.
− Letter of offer not to be dispatched to shareholders. Therefore not earlier than
21 days from its submission to SEBI.

V. Specified date
Acquirer to specify a date for the purpose of determining the names of the shareholders
of the target company to who letter of offers have been sent. Specified date shall not be
later than 30th day from the date of public announcement.

VI. Minimum number of shares to be acquired:

a) 20% of voting capital;

b) Acquirer may take more than 20% if he so desires but in that case 50% of
consideration is to be deposited in escrow account.
c) Reduction of public holding below 10%
− The acquirer within 3 months to acquire remaining shares (Resulting into
delisting of shares)
Or
− Disinvest through an offer for sale or by public issue within a period of 6
months.

d) If the shares offered are more than the shares agreed to be acquired.

Pro-rata Acquisition

28
VII. Offer Price:

Acquirer is required to make a minimum offer price which may be payable in

a) Cash
b) By exchange / transfer of shares of the acquirer company
c) Exchange / transfer of instruments with minimum 'A' grade rating from rating agency
d) Combination of (a), (b) and (c).

Minimum offer price shall be highest of

(For frequently traded shares)
a) The negotiated price under agreement for acquisition
b) Highest price paid by the acquirer the concert - including public or right issue during
26 weeks prior to public announcement.
c) Price paid by acquirer under preferential allotment made to him.
d) Average of weekly high low during last 26 weeks.

If shares are not frequently traded:

Minimum price will be in consultation with Merchant Bankers based on the following
factors:
a) Negotiated price
b) Highest price paid in past 26 weeks

VIII. Director’s Obligations:

a) Responsibilities of Acquirer company's Directors:

− Directors of the company to accept responsibility for offer brochure, circulars,
letter of offer or any advertising material.

b) Exemption from the Liability:

− If any director exemption, such director to issue statement to that effect
together with reasons thereof.

c) Prohibition to become a Director:

− During the offer period, the acquirer or person acting in concert with him shall
not be entitled to be appointed on the Board of Directors of Target Company.

d) Offer Conditional upon minimum level of acceptances:

Where an offer is conditional upon minimum level of acceptances the
Acquirer-

− Shall acquire shares from the public to the minimum extent of 20%
irrespective of public response to the minimum level of acceptance (Not
applicable if 50% amount payable is deposited in escrow account)

− Shall not acquire, during the offer period, shares in the target company except
by way of fresh issue of shares of the target company.

− Shall be liable for penalty of forfeiture of entire escrow amount for non-
fulfillment of obligations under the regulations.

29
 e) Restrictions on existing Directors:

− Existing Director is an insider within the meaning of SEBI Regulations and

such a person shall refuse himself / and not participate in any matters concurring
or relating to the offer including any preparatory steps leading to the offer.

f) Other Duties

i. Open escrow account on or before the date of issue of public announcement of

offer.
ii. Make financial arrangements for fulfilling obligation.
iii. To complete the procedures relating to offer within 30 days from the date of
closure.
iv. Prohibition of further offer of shares
− If acquirer has withdrawn the offer, he shall not make further offer for
acquisition for a period of six months.

− And if he has violated SEBI rules, he cannot make offer for any listed
company for a period of 12 months.

v. Disclosure of acquisition within 24 hours to

− Stock exchanges
− Merchant banks
− Details: No. of shares, Price paid, mode of acquisition.

vi. Prohibition of disposed or encumbrance of shares acquired, for 2 years unless

specifically stated.

IX. General Obligations of Target Company

During the period offer Target Company could

− sell, transfer or dispose of the assets of the company
− issue any authorized but un-issued securities
− enter into material contracts

List of shareholders to be furnished as required by the Acquirer:

− Within seven days of the request or specified date whichever is later.
− Once public offer is made, cannot appoint may additional director or fill in
any casual vacancy by any person representing or having interest in the
acquirer company.
− Director can send unbiased comments on the offer to shareholders but
Misstatement / concealment of material information will make them liable for
action.
− Facilitate the acquirer in verification of securities tendered for acceptances
− Transfer of securities in favour of the acquirer in certification of merchant
bankers.

X. General Obligations of Merchant Bankers

30
 a) Merchant Bankers to ensure that
− Acquirer is able to implement the offer made in terms of public announcement
of offer.
− Provisions relating to escrow account is made
− Firm arrangement of funds / money for payment through verifiable means to
fulfill SEBI regulations.

b) Contents of public announcement of offer and offer letter are true, fair and adequate
and based on reliable sources.

− Filing of letter of offer with SEBI, Target company and also Stock Exchange
where shares are listed.

− Issue of due diligence certificate

− Compliance with SEBI regulations
− Directions to Bank for release of escrow account.
− Report to SEBI: Within 45 days of closure of offer

XI. Competitive bids

a) Public announcement of competitive bid to be made

− within 21 days of first announcement of offer
− by any person

b) Quantum of Competitive bid should be atleast equal to the number of shares, which
was made under first offer.

i. Option to First Acquirer:

− Revise his offer
− Withdraw his offer with SEBI approval

ii. Upward Revision of offer price

− Any time upto 7 working days prior to the date of closure of offer.
− Acquirer shall not have the option to change other items.
− Increase escrow amount upto 10% of consideration payable on revision.
− Public announcement in all newspapers in which original offer was made.
− Inform : SEBI
Stock Exchange
Target Company

iii. Closure of offer:

− When there is a competitive bid, the date of closure of original bid as well as
date of closure of all subsequent bids shall be the date of closure of public offer
and the last subsisting competitive bid.

iv. Withdrawal of offer:

Once acquirer has made an announcement of public offer he can not withdraw
unless:

31
 − Withdrawal is consequent upon competitive bid by another.
− Statutory approvals required have been refused.
− The sole acquirer being natural person dies.
− Such circumstances which SEBI may permit.
− Withdrawal by -
o Public announcement in all publications when offer was made
o Inform : SEBI, Stock Exchange and Target company

XII. Other Aspects - Escrow Account:

The acquirer shall on the date of public announcement of offer create escrow account by
way of security for performance obligations under SEBI rules:

a) Amount :
− For consideration upto Rs. 100 crores 25%
− Above Rs. 100 crores 25% upto Rs. 100 crores
and 10% thereafter
− For offers which are subject to minimum level of acceptances and the acquirer
does not want to acquire more than 20% 50% of consideration
− Total consideration to be calculated for highest price.

b) Escrow Account to consist of

− Cash deposit with scheduled bank
− Bank guarantee
− Deposit of acceptable securities with appropriate managing with Merchant
Banker.

c) Conditions to be fulfilled
i. Cash deposit with scheduled bank: Acquirer to empower merchant banker to issue
cheque / DD as per SEBI rules.

ii. Bank Guarantee

To be in favour of Merchant Banker

Valid for a period of public announcement plus 30 days from the

closure of offer

d) Escrow with Security:

− Empower merchant banker to dispose of security by sale or otherwise.
− The guarantee / Securities shall not be returned till all the obligations under
SEBI Regulations are complied with.

e) Increase in value of Escrow:

i. Upon upward revision of offer:

− Additional value of 10% of consideration payable on such revision
− Additional deposit of 10% of value increases in consideration.

32
 ii. When Bank guarantees have been given as securities:
− Acquirer to give at least 1% of consideration payable by way of security

f) Release of Escrow Account

i. The entire amount to the acquirer upon withdrawal of offer with certificate of
merchant banker.
ii. Transfer of 90% to Special account opened.
iii. To the acquirer, balance 10% of cash on completion of all this formalities.
iv. Entire amount to Merchant Banker in the event of forfeiture due to non fulfillment
of SEBI Regulations.
v. In the event of forfeiture :
− Merchant Banker will distribute
o 1/3 rd of the amount to Target company
o 1/3 rd to Stock Exchange
o 1/3 rd to be distributed pro-rata among shareholders who accepted the
offer

g) Forfeiture of Escrow Account

− In case of non fulfillment of obligations under SEBI regulations, SEBI shall
forfeit escrow account in full or part.

− The merchant banker shall ensure realization of escrow account by

o foreclosure of deposit
o Invoking bank guarantee
o Sale of security

h) Payment of Consideration :
− Consideration payable in cash: within 21 days from the closure of offer.
− Open a special account with Banker to the Issue.
− Consideration payable in exchange of security: Acquirer to ensure that
securities are actually issued and dispatched.
− Unclaimed balance: To be transferred to Investors Protection fund after 3
years of date of deposit.

XIII. Bailout Takeover

a) What is bailout takeover?

− Bail out take over of financially weak but not sick unit.
− Financially weak: Erosion of 50% of its net worth but less than 100%
− Responsibility: Lead Institution to e responsible to ensure compliance of SEBI
Regulations.

b) Approval by Lead Institution:

− Taking into account financial viability
− Assessing requirement of funds for revival
− Drawing up revival package

33
c) Scheme may provide for:
− Change in management
− Exchange of shares
− Combination of both

d) Manner of Acquisition:
− Invitation of offer
− Information to offerors
o Management
o Technology
o Range of products
o Shareholding pattern
o Financial holding
o Past performance

e) Selection of the Party:

− Management competence
− Adequacy of Financial Resources
− Technical Capability

f) Manner of evaluating bid:

− Purchase Price
− Track Record
− Financial Resources
− Reputation of management

34
 Chapter Seven

Valuation of Shares

I. Introduction to Valuation:
The process of determining the current worth of an asset or a company is called
valuation. There are many techniques that can be used to determine value, some are
subjective and others are objective. For example, an analyst valuing a company may look
at the company's management, the composition of its capital structure, prospect of future
earnings, and market value of assets. Judging the contributions of a
company's management would be more of a subjective valuation technique, while
calculating intrinsic value based on future earnings would be an objective technique.

Every asset, financial as well as real, has a value. The key to successfully investing in
and managing these assets lies in understanding not only what the value is but also the
sources of the value. Any asset can be valued, but some assets are easier to value than
others and the details of valuation will vary from case to case. Thus, the valuation of a
share of a real estate property will require different information and follow a different
format than the valuation of a publicly traded stock. What is surprising, however is not
the difference in valuation techniques across assets, but the degree of similarity in basic
principles. There is undeniably uncertainty associated with valuation. Often that
uncertainty comes from the asset being valued, though the valuation model may add to
that uncertainty.

A postulate of sound investing is that an investor does not pay more for an asset than
its worth. This statement may seem logical and obvious, but it is forgotten and
rediscovered at some time in every generation and in every market. There are those who
are disingenuous enough to argue that value is in the eyes of the beholder, and that any
price can be justified if there are other investors willing to pay that price. That is patently
absurd. Perceptions may be all that matter when the asset is a painting or a sculpture, but
investors do not (and should not) buy most assets for aesthetic or emotional reasons
financial assets are acquired for the cash flows expected on them. Consequently,
perceptions of value have to be backed up by reality, which implies that the price paid for

35
 any asset should reflect the cash flows that it is expected to generate. The models of
valuation described here attempt to relate value to the level and expected growth in these
cash flows.

II. Role of Valuation in Acquisition Analysis:

Valuation should play a central part of acquisition analysis. The bidding firm or
individual has to decide on a fair value for the target firm before making a bid, and the
target firm has to determine a reasonable value for itself before deciding to accept or
reject the offer.

There are also special factors to consider in takeover valuation. First, the effects of
synergy on the combined value of the two firms (target plus bidding firm) have to be
considered before a decision is made on the bid. Those who suggest that synergy is
impossible to value and should not be considered in quantitative terms are wrong.
Second, the effects on value, of changing management and restructuring the target firm,
will have to be taken into account in deciding on a fair price. This is of particular concern
in hostile takeovers.

Finally, there is a significant problem with bias in takeover valuations. Target firms
may be over-optimistic in estimating value, especially when the takeover is hostile, and
they are trying to convince their stockholders that the offer price is too low. Similarly, if
the bidding firm has decided, for strategic reasons, to do an acquisition, there may be
strong pressure on the analyst to come up with an estimate of value that backs up the
acquisition.

III. Need for Valuation of Shares:

i. Assessment under estate duty, wealth tax, gift tax.
ii. Purchase of block of shares including acquisition of controlling interest in the
company.
iii. Formulations of schemes of amalgamation.
iv. Acquisition of interest of dissenting shareholders under reconstruction scheme.
v. Conversion of preference shares into equity
vi. Advancing loans against security of shares
vii. Compensating shareholders on the acquisition of their shares by the government
under a scheme of nationalization.

IV. Factors Affecting Valuation:

 Internal Factors:
Rate of dividend declared
Market / Current values of assets / liabilities
Goodwill
Market for the products
Industrial relations with employees
Nature of plant / machinery
Nature of plant / machinery
Expansion policies of the company
Reputation of Management

 External Factors:

36
 Competition
Relations with Govt. Agencies
Technological development
Taxation parties
Import / Export policy
Stability of economy
Stability of government in power
Political climate in country

V. Basis of Valuation:
1) Assets Value
2) Capitalized Earning Power
3) Market value
4) Book Value
5) Cost: Historical, Replacement / Substitution / Opportunity cost.

VI. Methods of Valuation:

Analysts use a wide range of models to value assets in practice, ranging from the
simple to the sophisticated. These models often make very different assumptions about
pricing, but they do share some common characteristics and can be classified in broader
terms. There are several advantages to such a classification -- it makes it easier to
understand where individual models fit into the big picture, why they provide different
results and when they have fundamental errors in logic.

Thus methods of valuation of shares are classified into two parts i.e.:
− Historical Perspective
− Modern Perspective

Historical Perspective:

In historical perspective we use the following methods:

− Net Asset Method
− Yield Method

1) Net Asset Method:

Also termed as Balance Sheet Method, Asset Backing Method or Break up value
method.

For instance: If assets total Rs. 50,000 and liabilities Rs. 10,000.
No. of shares 20,000
Net Asset value: Rs. 2

Points to be considered:
a) Proper value to be placed for Goodwill after business.
b) Fictitious Assets such as Preliminary expenses, debit balance in profit and loss
account etc to be excluded.
c) All other assets (including non-trading assets such as investments) should be taken
at market value. In absence of information about market value -- Book values
may be taken.

37
d) Liabilities payable to third parties and preference share capital should be deducted
from total assets.
e) It should be noted that item constituting part of the equity shareholders funds
(E.g. General Reserves; Profit and loss account credit balance, Debenture
Redemption Fund, Dividend Equalisation fund, Contingency Reserves should not
be deducted.
f) Net Assets so arrived at should be divided by no. of equity shares.

Illustration:

Balance Sheet of M/s Prosperous Ltd. As on 31. 3. 97

Liabilities Rs. Assets Rs.

Share Capital:
Authorized & Issued Land and Building 2,70,000
6000 shares of
Rs. 100 each 6,00,000 Plant and machinery 1,00,000
Profit and loss account 40,000 Stock 3,60,000
Bank overdraft 10,000 Sundry debtors 1,60,000
Creditors 80,000
Provision for taxation 1,00,000
Proposed dividend 60,000
8,90,000 8,90,000

Additional information: Profit before depreciation and taxation during last five years:

1992.93 1,70,000
1993.94 2,10,000
1994.95 1,80,000
1995.96 2,20,000
1995.97 2,00,000

- On 31st March, 1997 Land and Building were valued at Rs. 2,80,000 and Plant
and Machinery Rs. 1,20,000, Sundry debtors included Rs. 4,000 which were
irrecoverable.

- Having regard to the nature of business, a 10% return on net tangible capital
employed is considered reasonable.

- You are required to value the shares of the company

- Valuation of Goodwill may be based on five years purchase of annual super

profits.

- Tax rate to be assumed at 50%.

Solution:
Statement showing valuation of shares
Goodwill (see working note) 1,44,500
Land and Building 2,80,000

38
Plant and Machinery 1,20,000
Sundry Debtors 1,56,000
Stock 3,60,000
10, 60,500
Less: Liabilities:

Bank Overdraft 10,000

Creditors 80,000
Provision for taxation 1,00,000
Proposed dividend 60,000
2,50,000
Total 8,10,500

Value per share 8,10,500 / 6000 = 135.08

Working note:
i) Tangible capital employed:

Assets at their present value:

Land and Building 2,80,000
Plant and Machinery 1,20,000
Stock 3,60,000
Sundry debtors 1,56,000

9,16,000
Less: Liabilities
Bank Overdraft 10,000
Creditors 80,000
Provision for tax 1,00,000
1,90,000

Net tangible capital employed 7,26,000

Less: 50% of Profits (after tax) 50,000
Average capital employed 6,76,000

ii) Goodwill:

Total profits for five years 9,80,000

Less: Bad debts 4,000
Average 9,76,000
Less: Adjustment for change in
Depreciation in value of assets 1,95,000
Land and Bldg. 2% on 10,000 200
Plant and Mach. 10% on 200000 2000
1,93,000
Less: Taxation @ 50% 96,500
Average Annual profit 96,500
Less: 10% Return on Annual average
Capital employed 67,600

39
 Average Annual super profit 28,900
5 years purchase of super profits 1,44,500

2) Yield Method
The yield basis of valuation may take any of the following two forms
a) Valuation based on Rate of Return
b) Valuation based on Productivity factor

a) Valuation based on Rate of Return

The ‘rate of return’ refers to the return which a shareholder earns on his
investment. It may further be classified into:
- Rate of dividend
- Rate of earnings

i. Valuation based on Rate of dividend:

Paid up value of share x Profitable rate of dividend

Normal rate of dividend

E.g.:
Paid up value : Rs. 80
Normal dividend : Rs. 10
Possible Dividend : Rs. 12

Hence value 80 x 12 / 10 = Rs. 96.

ii. Valuation based on Rate of Earnings

Rate of earnings of company explains the effective utilization of company’s
assets. In case the company does not distribute 100% of its earnings among
its shareholders, it is a matter of fact strengthens the financial position of the
company.

Paid up value of shares x Possible earnings Rate

Normal earnings Rate

E.g.:
Paid up value : Rs. 80
Past earning Rate : Rs. 16
Expected earning rate : Rs. 20

Value: 80 x 20 = 100

16

iii. Valuation based on Price Earning Ratio:

Earning per share x Price Earning Ratio

40
 Earning Per share = Profit available for Equity shareholders

No. of Equity Shares

Price Earning Ratio = Market value of a share

Earning per share

E.g.:
Earning per share 10
Market value 40
Price Earning Ratio 04
In case EPS goes up 12

Value of share will be 12 x 4 = 48

iv. Capitalization Factor

The value of share can also be found out by finding capitalization factor or
multiplication
− If yield expected in the market is 8%
− The capitalization factor is 100 / 8 i.e. 12.5%
− Hence if a company earns profit of Rs. 4 lakhs
− Total value of Business will be Rs. 50 lakhs 4 x 12.5

v. Value of equity share:

Capitalized value of Business

No. of Shares

b) Valuation based on Productivity Factor:

- Productivity factor represents earning power of the company in relation to value of

the assets employed for such earning.

- The factor is applied to net worth of company on the valuation data to arrive at
projected earnings of the company.

- Projected earnings after necessary adjustments are multiplied by the appropriate

capitalization factor to arrive at the value of company’s business.

- Maturity value is divided by no. of shares to ascertain value of each share.

Procedure:
1) Ascertain average net worth of the business for relevant years
2) Ascertain the value of Net worth of business on valuation date
3) Average profit earned for the relevant years
4) Productivity factor = Average profit x 100

Average net worth

41
5) Productivity factor so obtained is applied to net worth of the business on valuation
date to ascertain projected income of business in future.
6) Projected income so calculated is further adjusted by making appropriations of
replacement / tax, etc. hence profit available to shareholders is arrived at.
7) The Normal rate of return for the company is ascertained by keeping in view nature
and size of the undertaking.
8) Appropriate capitalization factor or multiplier based on normal rate of return is
ascertained.
9) Capitalization factor is applied to projected profits to ascertain value of the
undertaking.
10) Capitalized value is divided by no. of shares.

Illustration:
The following figures relate to a company which has Rs. 10,00,000 in equity shares and
Rs. 3,00,000 in 9% Preference shares all @ Rs. 100 each.

Year Average Networth Adjusted Taxed Profit

(excluding investments)
1995 Rs. 18,60,000 Rs. 1,90,000
1996 Rs. 21,50,000 Rs. 2,10,000
1997 Rs. 21,90,000 Rs. 2,50,000

The company has investments worth Rs. 2,80,000 (at market value). On the valuation
date, the yield in respect of which has been excluded in arriving at adjusted taxed profit
figures. It is customary to similar types of the company’s to set aside 25% of taxed profits
for rehabilitation and replacement purposes. On valuation date, the net worth (excluding
investments) amounts to Rs. 22,50,000. The normal rate of return expected is 9%. The
company has paid dividends consistently within range of 8% to 10% on equity shares
over past 7 years and expects to maintain the same.

Required: Ascertain value of each equity share on the basis of productivity factor
applying suitable weighted averaging.

Solution:
Computation of Productivity Factor

Year Avg. N.W. Adjusted Weight Weighted N.W. Weighted adjusted

taxed Profits taxed Profits
199 18,60,000 1,90,000 1 18,60,000 1,90,000
5

199 21,50,000 2,10,000 2 43,00,000 4,20,000

6

199 21,90,000 2,50,000 3 65,70,000 7,50,000

7

42
 Productivity factor: 2,26,667 x 100 = 10.68%
21,21,667

Maintainable profit: 10.68% on 22,50,000 2,40,000

Less: Rehabilitation / Replacement Reserve @ 25% 60,075
1,80,225
Less: Preference dividend 27,000
Profit available for shareholders 1,53,225

Capitalized value of profit @ 9% 17,02,500

Add: Value of Investments 2,80,000
Total value of Assets 19,82,500

Value of Equity shares: 19,82,500 = Rs. 198.25

10,000

B. CCI Guidelines

Fair Value
Guidelines formed in 1977 / 78 made public on 13-7-1990
Valuation of shares according to the guidelines is computed after taking into account
following 3 elements:

1. Net Asset Value (NAV)

2. Profit Earning Capacity value (PECV)
3. Fair value (FV)

1. Net Asset Value:

Total Assets xx Shareholders Funds

Deduct: all liabilities i) Equity xx
1) Pref. Capital x ii) Free Reserves xx
2) Secured / unsecured creditors x Total xx
3) Current liabilities x Deduct: Contingent liability
4) Contingent liabilities x 1. x
2. x
3. x
4. x

Net worth xxx Net worth xxx

Add: Fresh Capital Issue Face value x

Total xxx
NAV Per share: M.V. / No. of shares

2. Profit Earning Capacity Value (PECV)

Years Profit Before tax Profit after tax Dividend declared

1
2

43
 3
4
5

Average Profit before tax (on basic or simple or weighted average basis) :______
Deduct provision for tax _________%
Average profit after tax
Deduct Preference dividend
Net Profit after tax
Add: Contribution to profits by fresh issue
Total profits after tax
No. of equity shares including fresh / bonus shares
EPS Capitalized EPS by Capitalization rate.

Capitalization Rate

15% in the case of manufacturing company’s (which may be modified / liberalized in

exceptional cases upto 12%

20% in case of trading companies

17.5% In case of intermediate companies i.e. company whose turnover from trading
activity is more than 40% but less than 60% of total turnover.

Contribution of Fresh Issue of Capital

½ x Fresh Capital x Existing Profit after tax
Existing networth

Market value: Average Market price

Year High Low Remarks
1
2
3 latest
4 Month-wise

In preceding 12 months average market price on the above basis:

3. Fair Value:
Fair value is worked out by averaging NAV and PECV.
Market value is not taken as direct element in calculating fair value.

But if fair value arrived at by averaging NAV and PECV, is less than MV, Weightage
is given for higher MV in the following manner:

If market value is higher or more by

i) 20% to 50% of F.V, Capitalisation rate is reduced to 12%.
ii) 50% to 75% Capitalisation rate is reduced to 10%.
iii) 75% and above of FV, capitalisation rate is reduced to 8%.

44
 Valuation of Shares and Exchange Ratio
When two or more companies are combined / merged, financial consideration,
generally in the form of exchange of shares is involved. This requires relative value of
each company’s shares to determine a particular exchange ratio.

Three Approaches:
o Earnings Approach
o Market value Approach
o Book Value Approach

1) Earnings Approach

EPS of Acquired Company

EPS of Acquiring Company

E.g. Earning per share of Acquiring Company is Rs. 5.

Earning per share of Acquired Company is Rs. 2.
Exchange ratio: 2 / 5 i.e. 4 or 4 shares of acquiring company will be given for 10
shares of acquired company or 2 shares of acquiring company for 5 shares of
acquired company.

2) Market value Approach

Market price per share of acquired company

Market price per share of acquiring company

For example:
Market value of share of Company A: Rs. 50
Market value of share of Company B: Rs. 25 and if A is acquiring B
Exchange Ratio : 25 / 50 = 0.5
i.e. A Ltd. will issue 1 share for 2 shares of B Ltd.

3) Capitalized Value of EPS

Steps: 1) Determining Average future earnings
2) Determining Capitalisation Rate
3) Determining of market value
EPS

Capitalisation Rate

EPS 30 Capitalisation Rate 15%

Market value 30 / 50 x 100 = 200

4) Exchange Ratio

Market Price per share of Acquired Company

45
 Market price per share of the acquiring company

5) Book value per share

Book value = Shareholders funds

No. of shares

= Net worth
No. of shares

Exchange Ratio = Book value per share of the acquired Co.

Book value per share of Acquiring Co.

Modern Perspective:

1) Dividend Discount Models :

Basis : The value of the stock is the present value of expected dividends on it.

Rationale: The value of any asset is the present value of expected future cash flows,
discounted at a rate appropriate to the riskiness of cash flows being discounted.

) General Model:
When investors buy stock, they expect to get two types of cash flows:
i) Dividends during the period they hold stock
ii) Expected price at the end of holding period

Since expected price is itself determined by future dividends, the value of stock is the
present value of dividends through infinity.
t=α
Value per share of stock Σ DPSt
t = 1 (1 + r) t

DPSt = Expected dividend per share

r = required rate of return on stock

Two inputs: Expected dividends

Required rate of return

Since dividend projections cannot be made through infinity, several versions of the
dividend discount model have been developed upon different assumptions about
future growth.

) The Gordon Growth Model:

Model: The Gordon Growth Model can be used to value a firm that is in ‘Steady rate’
with dividends growing at a rate that is expected to stay stable in the long term.

Value of stock = DPS1

46
 (r – g)

Where DPS1 = Expected dividends one year from now

r = Required rate of return for equity investors

g = Growth rate in dividends for ever

) Stable Growth Rate

Expected normal Growth rate in economy:
Expected inflation + Expected real growth

In U.S. 4% + 2% = 6%

In India 8% + 6% = 14%
In practical terms, the stable growth rate can not be higher than the normal growth
rate in the economy in which firm operates, if valuation is done in nominal (real)
terms.

If the firms operations are domestic, this will be the expected growth rate in domestic
economy. (For multi nationals, the relevant information will be the growth rate in
world economy).

Limitations: Highly sensitive to growth rate

Example: Expected dividend per share : US $ 2.50

Discount rate: 15%
Expected growth rate: 8%

Value of stock: 2.50 (0.15 – 0.08) = $ 35. 71

) Two Stage Dividend Model

This model allows for 2 stages of growth

Initial phase when growth rate is high

Subsequent steady rate: Where growth rate is stable and expected to remain so
for a long term.

Value of stock: PV of dividends during growth period + PV of terminal price

t= n
P0 = Σ DPSt + Pn
t = 1 (1 + r) t (1 + r) n

Where Pn = DPSn + 1
(rn - gn) (1 + r) n

Limitations of two stage dividend discount model:

i. Practical problem is in defining the length of extra ordinary growth period
ii. This model assumes that growth rate is high during initial period and is
transformed overnight to a lower stable rate at the end of the period. While these

47
 sudden transformations in growth can happen, it is more realistic to assume that
shift from high growth to stable growth happen gradually over time.
iii. Overestimating or underestimating growth rate can lead to significant errors in
value.

) Further modifications: H model for valuing growth:

i. This model is based on the assumptions that:
Equity growth rate starts at a high initial rate (ga) declines linearly over extra-
ordinary growth period (which is assumed to last 2
ii. H periods) to a stable growth rate (gn)
Dividend payout ratio is constant over time and is not affected by the shifting
growth rates.

P0 = DPS0 ( 1 + gn ) + DPS x H ( ga - gn )
r - gn r - gn

Stable growth Extra ordinary growth

Where P0 = Value of firm now per share

DPSt = Dividend per share in year t

r = Required return to equity investor

ga = Growth rate initially

gn = Growth rate at the end of 2H years applied for ever after that.

Limitations:
i. Growth rate is assumed to follow a structure laid out in the model deviations
from the structure can cause problem.
ii. Assumption of pay out ratio remaining constant in consistent.

Three Stage Discount Model:

This model assumes on initial period of stable high growth, second period of
declining growth and a third period of stable low growth that lasts forever.

t =n1 t = n2
P0 = Σ EPS0 ( 1 + ga) x IIa + Σ
t
DPSt + EPSn2 (1+gn) x IIn
t=1 t = n1 +1 (1 + r) t (r – gn) (1 + r) n

High growth Transition Stable growth

EPSt : Earnings per share in year t

DPSt : Dividends per share in year t
ga : Growth rate in high-growth phase ( lasts n1 years)

48
 gn : Growth rate in stable growth phase
IIa : Payout ratio in high growth phase
IIn : Payout ratio in stable growth phase.

2) Free Cash flows to equity discount models:

) Free Cash flows to Equity:

The FCFE is the residual cash flows left after meeting interest and principal payments
and providing for capital expenditures to both – maintain existing assets and create
new assets for future growth.

FCFE = Net Income + Depreciation – Capital spending - ∆ Working capital –

Principal repayments + New Debt Issues.

In a special case where capital expenditures and working capital are expected to be
financed at the target debt equity ratio δ and principal repayments are made from
new debt issues.

FCFE = Net Income + (1 - δ ) (Capital Exp. – Depreciation) + (1 - δ ) ∆

Working capital.

Why are Dividends different from FCFE?

The FCFE is a measure of what a firm can afford to payout as dividends.
a) Desire for stability
b) Future investment needs
c) Tax factors
d) Signaling prerogatives: Increase in dividends is viewed as positive signals and
decreases as negative signal.

) FCFE Models:
The stable-growth FCFE Model:
The value of equity, under the stable-growth model, is a function of expected FCFE
in the next period, the stable growth rate, and the required rate of return.

P0 = FCFE1
r - gn
P0 = Value of stock today
FCFE1 = Expected FCFE next year
r = Cost of equity of the firm

49
 gn = Growth rate in FCFE for the firm forever.

Illustration:
Earnings per share : $ 3.15
Capital Exp. per share : $ 3.15
Depreciation per share : $ 2.78
Change in working capital per share : $ 0.50
Debt financing ratio : 25%
Earnings, Capital expenditure, Depreciation, Working capital are all expected to grow
at 6% per year.
The beta for stock is 0.90. Treasury bond rate is 7.5%.
Calculate value of stock.

Solution:
Estimating value
Long term bond rate 7.5%
Cost of equity = 7.5% + (0.90 x 5.50%) = 12.45%
Expected growth rate 6%

Base year FCFE = Earning per share – (Capital Exp. – Dep.)

(1 – D /E Ratio) – Change in working capital
(1 – D / E Ratio)

= 3.15 – (3.15 – 2.78) (1 – 0.25) – 0.50 (1 – 0.25)

= 2.49

Value per share = 2.49 x 1.06 (0.1245 – 0.06) = $ 41.

3) Further modification in FCFE model

) Two stage FCFE model :

The value of any stock is the present value of the FCFE per year for the extra
ordinary growth period plus the present value of the terminal price at the end of the
period.

Value = PV of FCFE + PV of Terminal price

t =n
= Σ FCFEt (1 + r) t + Pn (1 + r) n
t=1

Where FCFEt = FCFE in year t

Pn = Price at the end of extra ordinary growth period
r = Required rate of return to equity investors in high growth period.

The terminal price is generally calculated using the infinite growth rate model:
Pn = FCFEn + 1 ( rn - gn )

50
 gn = Growth rate after the terminal year forever

rn = Required rate of return to equity investors in stable-growth period.

) Three stage FCFE model - E model

E-model is designed to value firms that are expected to go through three stages of
growth: an initial phase of high growth rates, a transition period where growth rate
declines and a steady state where growth is stable.

t =n1 t=2
P0 = Σ FCFEt + Σ FCFE1 + Pn2
t= 1 (1 + r) t L = n1 + 1 (1 + r) t (1 + r) n

Where P0 = Value of stock today

FCFEt = FCFE in year t
t = Cost of equity
Pn 2 = Terminal price at the end of transition period
= FCFEn2 + 1 / (r – gn)
n1 = End of the initial high growth period
n2 = End of transition period

 FCFE Valuation model v/s Dividend Discount valuation models:

FCFE model is alternative to dividend discounting model. But at times both provide
similar results:
When result obtained from FCFE and Dividend discount model may be same:
i) Where dividends are equal to FCFE.
ii) Where FCFE is greater than dividends but excess cash (FCFE- dividends) is
invested in projects with NPV = 0 (Investments are fairly priced)

When results from FCFE and Dividend discounting models are different:

i) When FCFE is greater than dividends and excess cash earns below market interest
rates or is invested in negative NPV – value projects, the value from FCFE will be
greater than the value from discount model.

ii) When dividends are greater than FCFE, the firm will have to issue either new
stock or new debt to pay their dividends- with attendant costs.

iii) Paying too much of dividend can lead to capital rationing constraints when good
projects are rejected, resulting in loss of wealth.

 Conclusion:
The dividend model uses a strict definition of cash flows to equity, i.e. expected
dividends on stock, while FCFE model uses an expensive definition of cash flows to

51
 equity as the residual cash flows after meeting all financial obligations and
investment needs.

When the firms have dividends that are different from FCFE, the values from two
models will be different.

In valuing firms for takeover or where there is reasonable chance of changing

corporate control, the value from the FCFE provides the better value.

Chapter Eight

Legal Issues Relating to Mergers and Acquisitions

Legal Issues Relating to Mergers and Acquisitions are as under:

I. Compliance under Companies Act

Companies Act does not define ‘Amalgamation’ or merger. However, provisions

under sections 391 to 396 deal with ‘Arrangements and compromise’ apply to
Mergers and Acquisitions.

Section 391 Power to compromise or make arrangements with creditors and

members

Section 392 Power of High Court to enforce compromises and arrangements

Section 393 Information as to compromise and arrangements with creditors and

members

Section 394 Provisions for facilitating reconstruction’s and amalgamation of

companies

i. Transfer to the transferee company of the whole or any part of the undertaking,
property or liabilities of the transferor company

ii. The allotment or appropriation of the transferee company of any shares /

debentures or other interests in the transferor company under the compromise arrangements.

iii. Continuation by the transferee company of any legal proceedings pending by or

against Transferor Company.

iv. Dissolution without winding up of Transferor Company

52
v. Provision for dissenting members

vi. Other consequential / supplementary matters.

Section 395 Power to acquire shares of dissenting shareholders under the scheme
approved by the majority.

Section 396 Power of the Central Government to provide for amalgamation in

national interest.

 Checklist of procedure for Amalgamation of Companies:

1) Review the Memorandum and Articles of Association of all amalgamating
companies to verify :

a) Power to amalgamate exists: Though these are views that such power is not
necessary, it is appropriate to consider amendment of memorandum to include
such powers.

b) Objects of Transferee company: Should include power to carry on the

business of transferor company if not amend the memorandum of transferee
company by amending the objects.

c) Any provisions under Articles: Requiring any special procedure to be

followed or approvals to be obtained.

2) Ensure that audited Accounts for the period ending on the appointed date are ready.

3) Hold Board Meetings: For approval of amalgamation and other incidental matters
including appointment of a director as authorized person to carry out various matters
on behalf of the company.

4) Carry out valuation of shares for each of the company.

5) Prepare necessary schemes and papers relating to amalgamation.

6) File an application with the Court seeking approval / directions of the Court.

7) Call meetings of shareholders / creditors under direction of the Court. Companies

will also have to issue necessary advertisements where required and applicable.

8) Hold the meetings, pass necessary resolutions approving amalgamation and related
matters.

9) In parallel, Transferee Company may also hold on-extra ordinary general meeting for
matters such as approval of issue of shares, increase of authorized share capital. File
special resolution with Registrar of company.

53
 10) File report of chairman of the meetings held under the courts directions within the
prescribed time.

11) Petition to the court for sanctioning the scheme of amalgamation.

12) Give appropriate notice to Central Government as required under Section 394 A.

13) Obtain official Liquidator’s report that the affairs of the company have not been
conducted in a manner prejudicial to the interests of the members of the company or
the public interest.

14) Obtain the order of amalgamation of the court

15) File certified copy of the order with Registrar of companies within 30 days.
16) Issue shares to the shareholders of the transferee company and file necessary return
of allotment under Section 75.

 Checklist for Acquisition and Divestiture of Business:

1. In case the acquirer is a company, check whether the objects permit:

a) Acquisition of new business

b) Carrying on of the business sought to be acquired.

2. Check whether objects of Seller Company permit sale of business.

3. Ensure compliance under Section 293 (1) (a) in case of sale of whole or substantially
whole of the undertaking.

4. Where the payment is to be made by issue of shares, ensure compliance with the
following by the company proposing to issue such shares :

a) Where the company is a public limited company, Section 81 (1A) of the

companies Act.
b) Where company is a listed company, provisions relating to
i) Listing agreement
ii) SEBI Takeover code should be complied with
c) Increase of Authorized Share Capital, where required, needs compliance.
d) Filing of return of allotment as required under Section 75 of Companies Act.

II. Provision of Sick Industrial Companies (Special Provisions) Act 1985:

- Amalgamation may be a measure for rehabilitation of a sick unit under SICA.

Section 18 of SICA, envisages amalgamation of a sick company with any other
company or vice versa (i.e. reverse merger)

- Section 18(2) of SICA gives wide powers to Board for Industrial and Financial
reconstruction (BIFR) with regard to amalgamation of sick unit with healthy unit.

o Change of constitution, name, memorandum, articles, Board of Directors.

54
 o Alterations, reorganization or reduction of capital.
o Transfer of property, assets or liabilities
o Any other measure necessary to effectively carry out scheme of
amalgamation.

- Section 32 of SICA gives BIFR wide powers to override any law except FERA and
urban land ceiling Act.

- BIFR can pass order regardless of what any other law provides.

- Provisions of Companies Act regarding amalgamation are not applicable.

- Approval of scheme by shareholders is not required, but shareholders of healthy

company involved in the amalgamation must approve it.
- BIFR has power to grant benefits under Section 72 A of Income tax.
 Procedure under SICA:

i. Reference to SICA by sick unit

ii. Declaration of unit as sick unit
iii. Appointment of operating agency.
iv. Operating agency to examine the viability of sick unit and prepare rehabilitation
scheme (including amalgamation with healthy unit)
v. Hearing of Scheme
vi. Inviting objections to scheme before sanction.
vii. Hearing different agencies having interest in the scheme
− Workers
− Government
− Creditors
Sanction of the scheme
viii. Power to appoint Directors on the Board
ix. Monitoring by operating Agency
x. Scheme will sanction various benefits in interest rates, repayment period, income
tax benefits, rationalization of labour, deferment of government dues etc. as may be
recommended by operating agency.

III. Foreign Exchange Management Act

Extracts from RBI notification under FEMA Notification FEMA 20 / 2000 RB dated
03/05/2000:

Issue and Amalgamation of shares after merger or demerger or amalgamation

of Indian companies:
Where a scheme of merger or amalgamation of two or more Indian companies or a
reconstruction by way of demerger or otherwise of an Indian company, has been
approved by courts in India the transferee company, or as the case may be, the new
company, may issue shares to shareholders of the transferor company, resident
outside India, subject to the following conditions:

a) Percentage of shareholding of the person resident outside India in the

amalgamated company does not exceed the percentage specified in the approval

55
 granted by the Central Government / Reserve Bank, when it exceeds approval of
RBI should be obtained.

b) Transferor Company or Transferee (Amalgamated) company shall not engage in

agriculture, plantation, or real estate business or trading in TDRs.

c) Reporting to RBI: Amalgamated Company to file details of shares held by

person’s resident outside India and furnishing confirmation that all the terms and
conditions stipulated by the scheme have been complied with.

Report to be submitted within 30 days of issuing shares.

Stamp Duty:
Stamp duty is required to be paid as per Laws of the State in which registered office
of the transferor / transferee companies are situated.

In Maharashtra stamp duty is 10% of the aggregate value of shares issued or allotted
in exchange or other wise and the amount of consideration paid for such
amalgamation. However amount of duty chargeable will not exceed:

i. An amount equal to 7% of true market value of immovable property located

within the state of Maharashtra of the transferor company

ii. An amount equal to 0.7% of aggregate of market value of shares issued or

allotted in exchange or otherwise and the amount of consideration paid for such
amalgamation whichever is higher of (i) or (ii).

IV. Income Tax Act: 1961

Various provisions of Income tax applicable to Mergers and Acquisitions are

summarized below:

Depreciation: Section 34
The amalgamated company can continue to claim future depreciation on the
assets transferred to it under scheme of amalgamation. However, such
depreciation be allowed on the written down value of the assets before
amalgamation and not as the value of the transferor of these assets.

Terminal Depreciation (Section 32 and Section 41)

The transfer of assets by the amalgamating company does not amount to sale of
assets provided amalgamated company is an Indian company. Hence, transfer
value of assets in an Amalgamation scheme may be more or less than the
written down value of assets. Such deficit or excess will neither be allowed as
terminal depreciation or will be chargeable to tax as balancing charge.

Capital Gains: Section 45 and Section 47

56
Transfer of Assets by an amalgamating company to an amalgamated company
under the scheme of amalgamation is not considered to be transfer for the
purposes of capital gains provided amalgamated company is Indian company.

 Expenditure on scientific Research, Acquisition of

patent rights or copy rights etc: Section 35, Section 35A
The amalgamated company can continue to have the benefits of writing off of
expenditure on scientific research; acquisition of patents and copy rights which
the amalgamating company could not enjoy because of the amalgamated
company is an Indian company.

 Set off and Carry forward of unabsorbed

depreciation and past losses: Section 72
Unabsorbed depreciation and past losses of the amalgamating company cannot
be carried forward by the amalgamated company except as provided under
Section 72 (A).

 Carry forward of losses in case of amalgamation

scheme under Section 72A
This section permits the amalgamated company to carry forward accumulated
losses and unabsorbed depreciation of amalgamating company subject to
following conditions:
1) Amalgamating company is Indian company
2) The Central Government on the recommendations of the specified
Authority is satisfied that :
a) Amalgamating company is not financially viable
b) Amalgamation is in public interest
c) Amalgamation shall facilitate rehabilitation or revival of the business
of amalgamating company.

3) The benefit of carry forward would be available only when following past
amalgamation conditions are fulfilled:
a) Amalgamated company should continue to carry forward business of
amalgamating company without any modification or reorganization
except as permitted by Central Government.
b) The amalgamated company should along with the return of income,
furnish a certificate from the specified authority to the effect that
adequate steps have been taken by the company to rehabilitation or
revival of the amalgamating company.

 Amortization of Capital Expenditure: Section 170

The amalgamating company will have to pay taxes on income upto the date of
amalgamation. The amalgamated company will have to pay tax after that date.
However, in the event of default by the amalgamating company, the amount of
tax not paid will be recoverable from the amalgamated company.

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 Chapter Nine

De-Merger & Reverse Merger

 Meaning of De-merger:
De-merger essentially means bonafide separation of the key business assets and
reorganizing the business in such a manner that though there is separation in favour of
another company, atleast 50% of the equity stake in two companies continues to be
common.

Section 2 (19AA) was introduced by Finance Act of 1999 defining De-Merger:

De-merger means transfer in pursuance scheme of arrangement under section 391 to 394
of the companies Act by de-merged company of its one or more undertakings to any
resultant company
In such a manner that:
i. All the property of the undertaking of demerged company immediately before
demerger becomes the property of resultant company.
ii. All liabilities relatable to the undertaking immediately before demerger, becomes the
liability of resultant company.
iii. Transfer of properties and liabilities is at book values.
iv. The resultant company issues its shares to the shareholders of demerged company in
consideration of demerger on proportionate basis.
v. Shareholders of not less than 75% of the value of shares of demerged company
become the shareholders of resultant company.
vi. Transfer of undertaking is on a going concern basis
vii. De merger is in accordance with the conditions if any, notified by Central
Government under Section 72 A(5).

Slump Sale: Section 2 (42c):

Means transfer of undertaking or unit or division or business activity as a whole for lump
sum consideration without values being assigned to individual assets and liabilities.
Profits or gains arising from slump sale shall be chargeable as long term capital gain.

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 Examples:
1) Sterlite Industries and Sterlite Optical:
Sterlite which was a diversified company with presence both in non-ferrous metal as well
as Telecom cables decided to de-merge both the business into separate companies. The
spin off was done in the ratio of 1:1.

2) Raymonds Ltd:
Raymonds sold of Cement and Steel business to become one again, a purely fabric and
garment company. The whole exercise fetched Raymonds Rs. 1140 crores. This enabled
it to reduce high cost debts as well as buyback its own shares. Thus financially as well as
in terms of shareholder value it was a correct step.

3) GE Shipping
The company has interests in shipping, property development, trading and finance. It was
decided to de-merge property development business strategically with effect from 1st
April, 1999.

4) ABB and ABB Alstom Power India Ltd.

As a result of the global de-merger of ABB group and its hiring off power generation
business with Alstom of France, ABB India was also de-merged in 1999. The objective
was to remain in areas of power distribution and transmission services. The independent
profitability of both the companies increased due to greater focus.

 Objectives of De-merger:
i. Restructuring of business with a view to create value for new knowledge driven
businesses.
ii. To give a new focus to high growth business
iii. Empower people in a better way.
iv. Generate fresh capital from the market

 Reverse Merger
 Reverse merger takes place when a healthy company merges into a financially
weak company. Under the Companies Act there is no difference between regular
merger and reverse merger. It is like any other amalgamation.

 Reverse merger can be carried out through the High Court mode, but where
one of the merging company is a sick industrial company under SICA, such merger
must take place through BIFR.

 On Amalgamation merger automatically makes the transferee company

entitled to the benefits of carry forward and set off of loss and unabsorbed depreciation
of the transferor company. There is no need to comply with Section 72 of Income Tax
Act.

 On amalgamation being effective, the weak company’s name may be changed

into that of a healthy company.

Examples:
i. Maneklal Harilal Mills Ltd. merging into Sick company Bihari Mills Ltd.

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 ii. Kirloskar Oil Engines Ltd. merged into Prashant Khosla Pneumatics Ltd. a sick unit.

 Case Study - Kirloskar Oil Engines merging into Prashant Khosla Pneumatics Ltd.

1) In April, 1994, Kirloskar Oil Engines Ltd. (KOEL) took over the management
control of Prashant Khosla Pneumatics Ltd. (PKPL) a Delhi Based Company having its
works at Nashik.

2) PKPL became a sick unit as on 31st March, 1994 and went into BIFR in June
1994. ICICI was appointed as Operating Agency who invited bids for PKPL for revival.
KOEL made a bid although PKPL was already under its control. KOEL’s bid was
accepted and confirmed by BIFR.

3) Main objective in the take over was to make use of PKPL’s engine plant for
KOEL’s large engine activity.

4) PKPL take over added to KOEL’s assets, two plants located at MIDC, Nashik
on MIDC leased land of 80,000 sq. mtrs.
5) A scheme for revival of PKPL through reverse merger of KOEL with PKPL
was submitted to BIFR and was sanctioned in February 1996.

6) Accordingly, KOEL merged in PKPL, and name of PKPL stood changed

KOEL on 1st March, 1996 which was the effective date of amalgamation.

7) Again of merged company for 1994-95 was held in April 1996 and
consolidated accounts for the year ended 31st March, 1995 were adopted. Delay of 7
months for holding AGM was condoned by BIFR.

8) This merger did not affect in any way KOEL shareholders.

9) PKPL capital of Rs. 218 lakhs was reduced by 95% to 11 lakhs and KOEL
shares were exchanged for PKPL shares in the merged company in the ratio of 1 for 20.

10) PKPL shareholders were paid 5% dividend for 1994-95 and full dividend for
1995-96.

11) 56% of PKPL's capital held by its holding company was transferred at agreed
price of Rs. 75 lakhs to KOEL associate company which subsequently got shares in the
merged company.

12) The scheme provided for certain matters without going through the formalities
under company's Act, under powers of BIFR such as
- Change of name of Transferee Company from PKPL to KOEL.
- Memorandum of association (MOA), articles of association (AOA) of Transferor
Company becomes MOA and AOA of Transferee Company.
- Auditors of Transferee Company to automatically cease to hold office and auditors
of the transferor company to become auditors of the transferee company.
- MD and ED of Transferor Company to continue as such in Transferee Company
without reappointment and without break.

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 - Authorized capital of Transferee Company to stand increased from Rs. 5 crores to
Rs. 27 crores.
- Transferee Company to allot to shareholders of Transferor Company, shares in
Transferee Company.
- Share certificates of Transferor Company not to be called back and replaced by
new certificates.
- ICICI to be issued 4,75,000 equity shares in transferee company without
complying with Section 81 (1A) and SEBI guidelines on preferential issue.

13) Stamp duty on transfer of property and share certificates was saved.

14) Premium payable to MIDC saved only loans for fee paid.

15) PKPL revival resulted into both the plants being operative- Direct
employment to more than 300 people working.

Chapter Ten

Post Merger Scenario

 Key Steps to Successful Post Acquisition Management

Realistic
Determined objectives
follow met
Continuous through
Immediate Communication
Actions

Very clear
Initial ideas

Experienced
Integrators

Normal Co.
Mgt.

Inadequate
tactical
preparation Wait and
See No Special
communication
Half
effort
hearted
integration Dropping
profit & dis-
satisfaction
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 Reasons for Strategic Success and Failure

• Common Strategic traps:

Strategy Ground Result

a) Desire to move an acquisition policy or a) A policy of this kind begets unrelated

“aggressive acquisition policy”. and messy situation that lead to
“Conglomerates” at best and at worst a de
stabilitating complexity that can be lethal.

b) Desire to acquire new technology b) More investment, more details to be

hitches, more regulatory approvals all resolved, unforeseen technical
combined to keep prize out of reach. In
many cases the previous owners sold out
as a means to resolving this problem.
c) Attractive past experience c) Purchase of obsolete concept-
particularly past performance of aging
firms.

d) Quest for complementarity’s d) Synergy may be illusory and may drive

away the company from their core business
to related but highly dangerous area.

e) Inability to walk away e) Once negotiations start, desire increases.

Nothing seems to deter buyer.
Price increases absorbed.

• Strategic Imperative:
The first priority for successful acquisition implementation is to know precisely what you
are buying and what are you going to do if and when the deal is completed.

• Valid strategy for successful acquisition policy:

i. To obtain presence for core business.

ii. To leverage marketing: Applying a massive marketing capability to a good product
line is an excellent base for an acquisition strategy.
iii. To build an enlarged base
iv. To reposition the business

• Drucker's five commandments for successful acquisitions

i. The acquirer must contribute something to the acquired company

ii. Common ore of unity is required.
iii. Acquirer must respect the business of acquired company

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 iv. Within a year or so, acquiring company must be able to provide top management to
the acquired company.
v. Within the first year of merger, management's in both companies should receive
promotions across the entities.

• Weston's Commentary on Drucker’s Pentalegue

i. Relatedness is a necessary requirement, but complimentary is an even greater virtue.

E.g.: Combining a company, strong in research but weak in marketing with a
company strong in marketing but weak in research may bring blessings to both.

ii. Relatedness or complementarities apply to general management functions such as

research, plants control and financial manager as well as firm specific operations of
production and marketing.

iii. Thus companies with cash flows or managerial capabilities in excess of investment
opportunities could effectively combine with companies lacking in financial or
managerial resources to make the most of the prospects for growth and profits in their
industries.

iv. An acquiring firm will experience negative results if it pays too much. It is difficult to
accurately evaluate another organization. There can be great surprises on both sides
after marriage. Expectation that a firm can improve average risk return relationship in
an unfamiliar market or industries is likely to be disappointed.

• Golden Rules of Integration

i. Plan First: If you don't know what you are going to do, don't do it.

ii. Implement quickly: If you are going to do it, do it immediately.

iii. Communicate frankly: Cost of error is always on the side of inadequate

communication. A change of plan can always be explained or admitted, with less
adverse effect on morale and hence productivity, than a policy of silence.

iv. Sensitivity in the treatment of people, recognition of long service and proper and
generous separation arrangements all count here.

 What constitutes Success?

• Meeting the objectives:

Most companies define success as meeting their acquisition objectives. In the case of
combined or integrated companies, this normally included such quantitative criteria as:
− Earning per share
− Profit before tax
− Revenue growth
− Return on assets employed
− Increase in Market share
− Increased in productivity

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 − Realization of synergy by reaping benefits of economies of scale: reduction inn
expenses of cost of operation.

• Enhanced shareholder value:

− Some experts argue that real criterion is not financial data but enhanced shareholder
value over a long period.

− Shareholder values appreciation in value of share price.

− Hence, increase in value of shares is perceived as increase in shareholder value.

 Short lived Mergers : Some Examples

a) Merger of ICICI and Anagram:

When employees of Anagram Finance heard that ailing firm was to be merged with
ICICI there was a sigh of relief.
But two months later, reality was bitter. Out of 450 staff only 140 were repaired and
all others were given pink slips with 3 months severance pay.

b) Merger of Burroughs Welcome with Glaxo:

After world wide merger of Burroughs Welcome with Glaxo in 1996, 150 top
managers left Burroughs Welcome.

c) Takeover of Merind by Wockhardt:

There was exodus of top management team of Merind.

d) CIBA and Sandoz merged to form Novartis:

115 out of 120 managers of new corporate office were Sandoz people with Sandoz
India's erstwhile MD John Simon ailing the shareholders.

e) ITC Classic with ICICI

Only 47 of 120 ITC classic executives were asked to remain. Its investment arm
Classic credit was shut down.

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 Chapter Eleven

Post Merger Integration

Seven Rules by Max Habeck – Fritz & Michael Tram

1) Vision:
Guide post merger Integration with a clear and realistic vision derived from through
business due diligence.

 Research Findings:
a) 78% of mergers are mistakenly driven by fit, and not vision.
b) Around 58% of mergers fail.

 What You Have To Do:

- Define What You Have To Do:

Assess not only what you possess in terms of competitive advantages, research
capabilities, and other resources but what your partner can do as well. This
knowledge comes form business due diligence which is market oriented, not just
finance oriented.

- Define Where You Want To Go:

What markets do you want to be active in? Where can you bring the combined
abilities of your new organization to bear, and in the process create something new
and powerful?

- Remain Realistic:
Credibility and clarity are crucial to creation of bold vision. A statement which is
unclear or unrealistic will not generate enthusiasm and will not be followed.

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- Don’t Copy Or Co-Opt:
Best vision can not be transferred like labels from one company to another. There
must be something which company’s employees and customers can uniquely identify,
based on the credibility and clarity of the statement.

- Communicate Constantly:
Visions live. Whether you call them a touch stone or acid test, they serve as a control
and a check on all major or minor – moves your new organization may take. Proper
and continual communication through out the organization will prompt your
employees ask themselves:” Is that us? “Is that what we really want to do?”, When
they take decision.

- Let “Fit” Follow:

If you have followed guidelines above, it seems only natural that the issues fit in all
their various forms – from financial to strategic should follow from the overall vision.
Trying it other way around does not work.

 M & A Cases That Have Failed On Account Of Lack Of Vision Or Unrealistic

Vision:

- AT & T and NCR:

In the late 1980s American Telephone and Telegraph still had assets such as Bell
Labs to go with long distance telephone services it kept after the 1984 anti trust break
up. The company had a grand vision of a technological synergy between its expertise
in telecommunications and NCR’s expertise in computer technology.

After years of intense searching, hampered by management changes as well as

cultural frictions, no synergies were found. The presumed fit between
telecommunication equipment and computer hardware failed to turn up.

AT &T spun off the remains of NCR around five years later at a loss of around $ 3.5
billion, nearly half of what it initially paid.

- Sony Pictures:
Sony acquired Columbia Pictures in 1989 for $ 5 billion. However, Columbia had
difficulties in generating the successful software to begin with. Rapidly rising salaries
of stars and lack of success at box office culminated in Sony making operating loss of
around $ 500 million. The company wrote off $ 2.7 billion. The losses were attributed
to abandonment of large number of projects and settlement of outstanding lawsuits.

However, instead of divesting the unit, Sony made management changes and imposed
stricter controls. Columbia is now a part of Sony Pictures Entertainment, which
represented just fewer than 10% of Sony Group’s Worldwide Sales of around $ 50
billion.

 Successful cases of M& A driven by Vision:

- MCI – World.com

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 - Acquisition of Salomon Inc. by Citigroup
- Nikko Securities by Citi Bank
- Ford Motor Acquisition of AB Volvo.

2) Leadership – It’s Critical Establish It Quickly

 Research Findings:
a) Leadership’s urgency is often neglected. Some 39% of all companies faced a
leadership vacuum because they failed to make the establishment of leadership a
priority.

b) A merger without strong leadership in place from its early days will drift quickly and
drift is deadly.

 What You Have To Do:

- Decisively Put A Leadership Blue Print In Place Prior To Closing The Deal:
Leadership patterns have to be communicated, understood and accepted.

- Keep The Keepers:

The top managerial talent in the combined organization should have already been
identified in your business due diligence. Whether you can simply convince them to
stay or whether you need “Golden Handcuffs”, you need to lock in the top talent
immediately.

- Act As Quickly As Your Situation Dictates:

The key word here is “speed”. Throw out the old time table, this call for a specific
feel for timing.

 Case Of Merger Which Have Failed One Leadership Issue:

- Monsanto & American Home Products:

In June 1998, Monsanto and American Home Products unveiled $ 35 billion merger
plan which on surface had plenty to offer both companies. The deal would have
combined Monsanto’s pipeline of biotechnology with marketing strength of AHP.
The merger fell through due to poor struggle between Monsanto CEO Robert Shapiro
and his counterpart at AHP, John Stafford.

3) Growth: Merge To Grow, Focus On Added Value & Not On Efficiency

Synergies

 Research Findings:
76% of the companies surveyed focused too heavily on “efficiency” synergies. 30%
of the companies virtually ignored attractive growth opportunities such as cross
selling possibilities or knowledge sharing in research and development.

 What You Have To Do:

- Begin Capturing Growth Synergies As Early And As Quickly As Possible:

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 Growth opportunities should follow directly from long term, growth – oriented, “one
business” vision. There are usually growth synergies i.e., potential to increase sales
quickly in customer, product and /or geographic segments. These complement the
savings potential in shared processes and procurement.

- Prioritize Areas Of Cost Savings:

Your due diligence work, combined with benchmarking, should reveal where the
efficiency synergies are located. Find them, prioritize them and realize them.

 Synergy Suicide - Cost Reduction Is Not A Driving Force:

- Wells Fargo & Co / First Interstate Bancorp:

These two competitors merged in $ 11.3 billion transaction in 1996, to realize
efficiency synergies of $800 million from saving operating costs. These were
achieved in part by reducing work force by 20%. Wells Fargo also discovered
considerable saving potential in information technology. Wanting to move quickly, it
set a deadline of only seven months for integrating the computer system at all First
Interstate Bancorp branches. It nearly reached the goal, but the efforts harmed internal
and customer relationships. The company later attributed a decline in operating profit
to back office problems resulting from the first Interstate integration.

 Most Successful Growth Through Mergers:

- Cisco Systems:
This fortune 500 company has grown since its founding in 1984, thanks to a
combination of organic growth and successful integration of 25 acquisitions. Cisco
has almost quadrupled its revenue since 1995 to $ 8.5 billion and its net income
tripled to $ 1.3 billion. It holds a market share of around 80% routers and switches
which form the internet infra structure.
Making mergers is and will continue to be absolutely essential for Cisco to maintain
its rapid growth and enhance its competitive advantages.

4) Early Wins : Act, Get Results & Communicate – Make Tangible, Positive Moves
:

 Research Findings:
a) Very few companies attempt to achieve early wins in an external or outward looking
area, such as in their relationship with suppliers or customers.

b) 61% of the merged companies search for early wins in the wrong place by focusing
on job shedding, factory closings or other inward looking cost moves. The emotion
attached to such moves can back fire and quickly turn them into early losses.

 What You Have To Do:

- Do Your Due Diligence:

You can only get early wins if you have done your due diligence properly.

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- Design Early Wins According To The Buy-In Needs:
You need the sensitivity to know what you need and what your situation is, to identify
more precisely where you should look and to determine how substantial a move you
should make. In this case, it is better to err on safer side of something small and
manageable.

- Look Internally, But Above All Look External:

Early wins in outward looking areas such as customers and suppliers can have a high
impact, but are often neglected at the expense of internal focused early wins.

- Focus On Assets, Customers And Knowledge:

These are rich sources of early wins.

- Get Cost Cutting Out Of The Way As Quick As Possible:

But do not sell these as early wins.

- Gather Information By Asking And Listening:

This gets constituencies involved.

- Communicate Complete Tasks Quickly:

But without any exaggeration

5) Cultural Differences: Handle A “Soft Issue With Hard Measures”:

Cultural imposition is not always the option. It is often more suitable to compound the
cultures or even let them remain separate.

 Research Finding:
a) It is common to blame cultural differences when merger fail.
b) Cultural imposition is the norm.

 What You Have To Do:

- Develop The Strategy For Cultural Integration Before Merger:

Decide if you are going to impose one of the cultures leave them separate, or create a
compound culture. Before imposing culture be sure that the new culture is better than
the one it replaces.

- Put The Leadership Team In Place Quickly:

Minimize uncertainty and a cultural “void” the leadership team must behave as a
cohesive group.

- Perform Through Cultural Assessment:

Understand the differences between two cultures, identify potential barriers and
misunderstandings. Legitimize and discuss the differences. Include organizational
system such as HR, reporting and IT in this assessment.

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- Decide What You Want The New Culture To Be:
If you are creating a compound culture, define what you want the new culture to be
and why actively encourage the emergence of something entirely new which builds
on the strengths of both partners.

- Build Links Between The Two Organizations:

There is nothing like working together to build understanding.

- ANCHOR NEW CULTURE THROUGH A CULTURAL CURRENCY:

Set up a system of incentives and penalties to enforce and encourage the new norms
and processes. Make sure the new leadership team acts as role models to continually
reinforce the desired level of behaviour. Deal firmly with people who try to
undermine the new direction.

- Have Patience
It takes time for people to adjust to a new cultural reality.

6) Communication: Real Force Behind Buy In, Orientation And Expectations: Plan
Your Communication According To Timing And Target, Get Word Out, And
Actively Obtain Feed Back:

 Research Findings:
a) 86% of companies said they failed to communicate their new alliance sufficiently in
their merger integration plan.

b) Most commonly cited barrier to merger integration is “failure to achieve employee

commitment”. Some 37% of respondents cited this as the primary obstacle to
overcome, well ahead of obstructive behaviour and culture barriers.

 Remember That You Are Always Communicating:

“Non communication “is still communication because it sends messages you are just
not in control of what the messages are, and the grapevine will decide. The grapevine
is the single most effective communications medium in your company. Give it good
reasons to circulate positive messages.

 Follow A Framework To Help You Manage The Complexity:

Understand all your stakeholders, know your own communication goals, write a plan,
craft messages positively and effectively, pick appropriate media. Then actively
obtain feedback to know when you have achieved your goals. Set high standards and
make sure you have channels of access.

 Check your commitment to your message and your ability to communicate it

consistently, firmly and honestly.

 What You Have To Do

- Recognize That All Your Merger Goals Depend On Communication:

You have to persuade other people to believe in your vision and to act to bring it
about. This is a communication task, pure and simple.

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- Know Your Communication Goals:
At all times, with all stock holders, be consciously aware of your own goal for the
communication. This also involves knowing your constituencies, including
employees, unions, investors, customers, suppliers, the financial community, the local
and state governments.

- Be Flexible:
Use all your skills to make the best choices about how to communicate most
effectively. Use more than one medium and be prepared to change how you
communicate whenever necessary.

- Listen
Use whatever method you can to understand whether you have achieved your
communication goals. Dialogue is the richest form of feed back, but it is certainly not
the only one. Indirect indicators such as personal behavior, levels of absenteeism and
of course, share price – also tell you how your message has been heard.

7) Risk Management: Be Proactive, Not Reactive. Prioritize Projects, Then

Identify, Categorize and Embrace Risks And Do It Continuously.

 Research Findings:
32% of merging companies actively pursue formal risk management. Some of these
employ risk management so efficiently that it has become a source for both early wins
and long term growth.

 What You Have To Do:

- Assess Your Situation:

Then priorities your post merger integration projects according to their business
criticality and their complexity.

- Derive The Risks Inherent In Your Projects:

By making assumptions regarding those issues

- Categorize Your Risks:

According to “high, medium, low” Pin point the showstoppers which can spell death
to your merger plans.

- Vigorously Attack Those Risks You Can Overcome:

Minimize the importance of the ones which are not as easily and quickly overcome.

- Monitor Process Diligently:

Repeat it from the beginning on a regular basis. Every move you make changes your
internal circumstances and your external circumstances are constantly changing as
well. This is fluid, dynamic process, not a one time solution.

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