Master in Business Administration Semester 3 MF0011 Mergers and Acquisitions - 4 Credits (Book ID: B1209) Assignment Set- 1 (60

0 Marks)
Note: Each question carries 10 Marks. Answer all the questions. Q.1 What are the basic steps in strategic planning for a merger? Answer: Mergers & Acquisitions are strategic decisions which are taken by the management of any company after through examination of many important facts and considerations. Since decisions regarding Mergers & Acquisitions, like capital budgeting decisions are irreversible in nature it is very important that due attention must be paid to some basic issues before planning about it. Hence the strategic planning can be broken down into five steps: Step 1: Pre Acquisition Review The first step is related with the assessment of company's own situation to determine if a Merger & Acquisition strategy should be implemented or is there any other alternative? If a company expects difficulty in the future when it comes to maintaining growth, core competencies, market share, return on capital, or other key performance variable, then a Merger & Acquisition (M & A) program may be necessary. If a company is undervalued or fails to protect its valuation, it may find itself the target of a merger. Therefore, the pre-acquisition review will include issues like the projected growth rate, inability of the company to sustain its market share in the future because of the potential threat from its competitor firms, under valuation of the company etc. The company must address to a fundamental question. Would the Merger help improve the situation regarding the above or not? Will it affect the valuation in a positive manner? Step 2: Searching and Screening of the targets The second step in the Merger & Acquisition process is to search for those companies which can be the potential takeover candidates. It is important for the merging company to see whether the company to be acquired has strategic compatibility with the acquiring company or not. Compatibility and fit should be assessed across a range of criteria size, kind of business, capital structure, core competencies, etc. Searching and screening process should and must be performed by the management of the Acquiring Company without taking the help of any outside agency. Dependence on external firms should be kept minimum however if it is important to take the help of any outside agency.

Step 3: Valuation of the target company The third step in the Merger & Acquisition process is to perform a thorough and detailed analysis of the target company. Acquiring company must confirm that the Target Company is truly a good fit with the acquiring company. This requires a thorough review of operational, strategic, financial, and other aspects of the Target Company. This detail review is called "due diligence." Due diligence is the process of identifying and confirming or disconfirming the business reasons for the proposed capital transaction. Various factors like, customer needs, strategic fit, shareholder value etc is at the core of the analysis. Several functions are involved in due diligence related to potential acquisitions, including strategy, finance, legal, marketing, operations, human resources, and internal audit services. The direction of due diligence efforts depends on what the company expects to gain from the transaction: employees, customers, processes, products, or services. Due Diligence is initiated once a target company has been selected. The main objective is to identify various synergy values that can be realized through an M & A of the Target Company. A key aspect of due diligence is the valuation of the target company. In the preliminary phases of M & A. Total value of the company is calculated keeping in mind the value of the synergy expected from the combination and costs involved in the transaction. An example should give an idea of the calculation involved. Value of Acquiring Company = Rs. 500 lakh Value of Target Company = Rs. 250 lakh Value of Synergies as per Phase I Due Diligence = Rs. 150 lakh M & A Costs = Rs. 60 lakh Total Value of Combined Company = Value of the acquiring company + Value of the target company + Value of the Synergy M & A cost Hence Total value of the combined company = 500 + 250 + 150 60 = Rs 840 lakh. Step 4: Negotiation After selecting the target company it's time to start the process of negotiating. A negotiation plan is developed based on several key questions: How much resistance Acquiring Company is expected to encounter from the Target Company? What are the benefits of the Merger for the Target Company? What will be the acquiring company's bidding strategy? How much acquiring company should offer in the first round of bidding? The most common approach to acquire a company is for both companies to reach an agreement concerning the Merger & Acquisition. The idea is to go for a negotiated merger. The negotiated merger should be the preferred approach to a M & A since when both the company's agree to the deal then there are chances that the process will be a smooth one and will go a long way in making the merger a successful one. Step 5: Post Merger Integration

If everything goes as per planning, the two companies announce an agreement to merge the two companies. This leads to the fifth and final phase within the M & A Process, the integration of the two companies. Every company is different in terms of operations, in terms of structure, in terms of culture, in terms of strategies etc. The Post Merger Integration Phase is the most difficult phase within the M & A Process. It is the responsibility of the management of the two companies to bring the two companies together and make the whole thing work. This requires extensive planning and design throughout the combined organization. If post merger integration is successful, then it should result in the generation of synergy and that is the final objective of any Merger & Acquisition program.

Q.2 What are the sources of operating synergy? Answer: Operating synergies are those synergies that allow firms to increase their operating income from existing assets, increase growth or both. Operating synergies sources can be categorised into four types. 1. Economies of scale: Economies of scale may arise from the merger, allowing the combined firm to become more cost efficient and profitable. Economies of scales can be seen in mergers of firms in the same business (horizontal mergers). For example, two banks combining together to create a larger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. Both the banks after combination can expect to cut costs considerably on account of sharing of their resources and thus avoiding duplication of facilities available. 2. Greater pricing power: Greater pricing power from reduced competition and higher market share, should result in higher profit margins and operating income. This synergy is also more likely to show up in mergers of firms which are in the same line of business and should be more likely to yield benefits when there are relatively few firms in the business. When there are more firms in the industry ability of firms to exercise relatively higher price reduces and in such a situation the synergy does not seem to work as desired. An example of limiting competition to increase pricing power is the acquisition of Universal luggage by Blow Plast. The two companies were in the same line of business and were in direct competition with each other leading to a severe price war and increased marketing costs. After the acquisition Blow past acquired a strong hold on the market and operated under near monopoly situation. Another example is the acquisition of Tomco by Hindustan Lever. 3. Higher growth: Higher growth in new or existing markets arising from the combination of the two firms. This can be the case, for example, when a firm acquires

an emerging market firm with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products. 4. Combination of different functional strengths: Combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. The phenomenon can be understood in cases where one company with an established brand name lends its reputation to a company with upcoming product line or a company. A company with strong distribution network merges with a firm that has products of great potential but is unable to reach the market before its competitors can do so. In other words the two companies should get the advantage of the combination of their complimentary functional strengths. Synergy results from complementary activities. This can be understood with the following examples. Example Consider a situation where there are two firms A and B. Firm A is having substantial amount of financial resources (having enough surplus cash that can be invested somewhere) while firm B is having profitable investment opportunities ( but is lacking surplus cash). If A and B combine with each other both can utilise each other strengths, for example here A can invest its resource (cash) in the opportunities available to B. Note that this can happen only when the two firms are combined with each other or in other words they must act in a way as if they are one.

Q.3 Explain the process of a leveraged buyout. Answer: In the realm of increased globalized economy, mergers and acquisitions have assumed significant importance both within the country as well as across the boarders. Such acquisitions need huge amount of finance to be provided. In search of an ideal mechanism to finance an acquisition, the concept of Leveraged Buyout (LBO) has emerged. LBO is a financing technique of purchasing a private company with the help of borrowed or debt capital. The leveraged buy outs are cash transactions in nature where cash is borrowed by the acquiring firm and the debt financing represents 50% or more of the purchase price. Generally the tangible assets of the target company are used as the collateral security for the loans borrowed by acquiring firm in order to finance the acquisition. Some times, a proportionate amount of the long term financing is secured with the fixed assets of the firm and in order to raise the balance amount of the total purchase price, unrated or low rated debt known as junk bond financing is utilized. 1 Modes of purchase There are a number of types of financing which can be used in an LBO. These include, for example, the following (in order of their risk):

1. Senior debt: This is the debt which ranks ahead of all other debt and equity capital in the business. Bank loans are typically structured in up to three trenches: A, B and C. The debt is usually secured on specific assets of the company, which means the lender can automatically acquire these assets if the company breaches its obligations under the relevant loan agreement; therefore it has the lowest cost of debt. These obligations are usually quite stringent. The bank loans are usually held by a syndicate of banks and specialized funds. Typically, the terms of senior debt in an LBO will require repayment of the debt in equal annual installments over a period of approximately 7 years. 2. Subordinated debt: This debt ranks behind senior debt in order of priority on any liquidation. The terms of the subordinated debt are usually less stringent than senior debt. Repayment is usually required in one bullet payment at the end of the term. Since subordinated debt gives the lender less security than senior debt, lending costs are typically higher. An increasingly important form of subordinated debt is the high yield bond, often listed on Indian markets. High yield bonds can either be senior or subordinated securities that are publicly placed with institutional investors. They are fixed rate, publicly traded, long term securities with a looser covenant package than senior debt though they are subject to stringent reporting requirements. 3. Mezzanine finance: This is usually high risk subordinated debt and is regarded as a type of intermediate financing between debt and equity and an alternative to high yield bonds. An enhanced return is made available to lenders by the grant of an equity kicker (e.g. warrants, options and shares), which crystallizes upon an exit. A form of this is called a PIK, which reflects interest Paid In Kind, or rolled up into the principal, and generally includes an attached equity warrant (for larger financings) 4. Loan stock: This can be a form of equity financing if it is convertible into equity capital. The question of whether loan stock is tax deductible should be investigated thoroughly with the companys advisers 5. Preference share: This forms part of a companys share capital and usually gives preference shareholders a fixed dividend and fixed share of the companys equity (subject to there being sufficient available profits) 6. Ordinary shares: This is the riskiest part of a LBOs capital structure. However, ordinary shareholders will enjoy majority of the upside if the company is successful. 2 Governance aspects of leveraged buyouts Every restructuring programme must generate some additional values for the business, owners, shareholders etc. So an LBO exercise also creates certain additional values for various groups involved in such an operation. The sources of value generated are as follows: (a) Reduction in agency cost is the most important sources of value in an LBO. An LBO refers to take a public corporation to private. In case of a public corporation, the

management is different from owners. In practice, however, the management sometimes takes some suboptimal decisions without the prior approval of its owners, which are proved to be costly and detrimental to the growth of the firm and beneficial to the management. (b) The second source of value gain is associated with efficiency. It is argued that a private firm is much more efficient in taking decisions relating to a changing environment than that of a public corporation, where every decision is not required to be ratified by the general body before implementation. Thus, action can be taken more speedily since major new programmes do not have to be justified by detailed studies and reports to the board of directors. It is this efficiency in decisionmaking that creates value for an LBO. (c) Another source of value gain in case of an LBO is tax benefits as in such an operation; the interest obligation of the private firm is expected to certain tax benefits. The concept of stepping up of assets for depreciation as an ingredient of LBO calls for additional tax advantages. (d) Finally, it is understood that management or investors in an LBO deal have more information on the value of the firm, than the ordinary shareholders. Because of this information, a buy out proposal gives indication to the market that the post buy out scenario would certainly provide more operating incomes than previously expected or that the firm is less risky than perceived by the public at present. It is this asymmetric information, which adds value to an LBO and because of this value; the buy out investors do not mind paying large premiums on such deals. The value so created through an LBO exercise are exclusively meant for shareholders of restructured firm and partly for the specialists engaged in such an operation. Basically, this is considered as a wealth transfer mechanism in a sense that because of the financial leverage, the gain achieved by the shareholders came at the expense of the firms debt holders. 3 Leveraged buyouts and corporate governance LBO firms today are seeking to build value in acquired companies by improving profitability, pursuing growth including roll-up strategies (in which an acquired company serves as a platform for additional acquisitions of related businesses to achieve critical mass and generate economies of scale), and improving corporate governance to better align management incentives with those of shareholders. As a general rule, funds raised by private equity firms have a number of fairly standard provisions: Minimum commitment: Prospective limited partners are required to commit a minimum amount of equity. Limited partners make a capital commitment, which is then drawn down (a takedown or capital call) by the general partner in order to make investments with the funds equity. Investment or commitment period: During the term of the commitment period, limited partners are obligated to meet capital calls upon notice by the general partner by

transferring capital to the fund within an agreed-upon period of time (often 10 days). The term of the commitment period usually lasts for either five or six years after the closing of the fund or until 75 to 100% of the funds capital has been invested, whichever comes first. Term: The term of the partnership formed during the fund-raising process is usually ten to twelve years, the first half of which represents the commitment period (defined above), the second half of which is reserved for managing and exiting investments made during the commitment period. Diversification: Most funds partnership agreements stipulate that the partnership may not invest more than 25% of the funds equity in any single investment. 4 Stages of leveraged buyouts operation Four distinct but related stages are envisaged for the proper implementation of LBO programs, which are described below. 1st stage: Arrangement of finance: The first stage of the operation consists raising the cash required for the buy outs and working out a management incentive system. The equity base of the new firm consists of around 10 percent of cash put up by the company's top management or buy out specialists. Outside Investors like merchant bankers, venture capitalists and commercial banks then arrange to provide the remaining equity. Usually 50 per cent of the cash is raised by borrowings against company's assets in secured bank acquisition loans from commercial banks. Rest of the cash is obtained by issuing certain debts in a private placement, usually with pension funds, insurance companies, venture capital firms or public offerings through high-risk high-yield junk bonds. Private placements and and junk bonds are subordinated forms of debts (often referred to as mezzanine money') and they secure a place in between the secured debts from banks and risky residual claims of share holders. 2nd stage: Going private: In this stage, the organizing or sponsoring group purchases all the outstanding shares of the target company and takes it private through stock purchases format or purchase all assets through asset purchasing format. For the latter case, the purchasing group forms another new, privately held corporation. To reduce the debt by paying off a part of bank loans, the new owners sometimes sell off part of the corporation and may begin disposing of the inventory. 3rd stage: Restructuring: In this stage, the new management would try to enhance the generation of profit and cash flows by reducing certain operating costs and changing the marketing strategy. For this operation, it may adopt any or all of the below given policies: viz. (a) Consolidation and reorganization of existing production facilities;

(b) Changing the product mix (thereby changing the quality of the product) and changing the policy relating to customer services and pricing. (c) Trimming employment through attrition; (d) Phasing out employees in turn and reduction on spending on research and development, new plants and equipments, etc., so long as there is a need toredeem the fresh acquired debts; (e) Extraction and implementation of better terms from various suppliers. However, while undertaking the above stated restructuring activities due attention should be given for the approval of genuine capital expenditure programs for the growth of the firm, otherwise, the long term growth of the firm would hamper. 4th stage: Reverse leveraged buyouts: Under this stage, the investor group may take the company to public again, if the already restructured company emerges stronger and the goals set by the LBO groups have already been achieved. This is known as the process of 'Reverse LBO' or the process of 'Going Public', where the process it effected through public equity offerings. The sole purpose of this exercise is to create liquidity for existing shareholders. This type of reverse LBO is executed mostly by ex-post successful LBO companies.

Q.4 What are the cultural aspects involved in a merger. Give sufficient examples. Answer: Cultural compatibility is one of the most significant determinants of a successful M&A transaction. Acknowledging whether cultural compatibility can exist should be a factor in determining whether to pursue a given deal. Integration can never be attaining and growth strategies never realized if two companies are worlds apart culturally. This alignment of cultures can be achieved through information sharing, emphasizing similarities and mitigating dissimilarities through effective communication. Organizational culture has been identified by some analysts as a key determinant of the outcomes achieved as a result of Daimler-Benz's acquisition of Chrysler Corporation. In speaking to risks associated with this acquisition, one analyst suggested that "when it comes to downside risks, the greatest is certainly culture. Beyond the fact of both being carmakers, the two companies differ in just about everything: language, markets, work traditions and governance. And in the executive suite, how will Chrysler's sky-high American salaries and stock options fit with the German structure of employee representation and a supervisory board?" However, a position articulated by Jurgen Schrempp, the chairman of Daimler-Benz, in a discussion of his firm's acquisition of Chrysler indicated an awareness of culture as a key component of organizational fit and the acquisition's success. In Schrempp's words, "We are set to build a truly global culture."

Robert Eaton, Chrysler's former chairman, supported this intention by observing that "this is precisely one of the reasons we immediately agreed to run the business initially together. We both believe that integrating and merging cultures is possibly the greatest art of management." Thus, there appears to be a commitment between the top executives of the acquiring and acquired firm to take definitive actions to prevent organizational culture from having a negative effect on the acquisition. In some countries, the host government provides strong incentives to foreign firms to use joint ventures as a mode of entry into their markets. Another reason to form joint ventures is to gain rapid access to new markets. Learning is another objective behind many international joint ventures. By partnering with local companies instead of entering a market on their own, foreign firms can more quickly develop their ability to operate effectively in the host country. IJVs also provide a means for competitors within an industry to leverage new technology and reduce costs.

Q.5 Study a recent merger that you have read about and discuss the synergies that resulted from the merger. Answer: Recent merger: TATA STEELS ACQUISITION OF CORUS India inc. is on a foreign acquisition spree and tata steel is leading the pack. The India steel major has successfully bagged quite a few companies in asia. Recently, it has aquired corus, the biggest steel company in the uk. Corus was formed after the merger between british steel and dutch group hoogovens in the year 1999. corus is the ninth largest steel company globally and leads the market position in construction and packaging in Europe. Tata steel initially offered $7.64 bn in cash for the acquisition of the uks largest steel company. But corus has accepted the deal at euro 4.3bn [$8.1bn]. tata has offered 455 pence per share and pledged to contribute euro126 mn to the corus pension fund as part of the deal. They will also increase the annual contributions to the british steel fund. There are a few risks in this deal. The foremost risk is that tata steel will have to pay off huge debt of euro bn ,if there is an economic downturn in future. Tata group have taken euro1bn of the debt for buying corus. The fast changing global steel industry is witneesing the increasing trend of consolidation and this take over is done at the right time with the right partner for right

terms. ARCELOR Arcelor was formed on February 19,2001 with the merger of the three European group: the French usinor, Spanish aceralia and the Luxembourg arbed. It is registered in Luxembourg and listed on various stock exchanges on February 18,2002. in order to maximize the generation of cash and to ensure the sustained profitability,it designed its businees model by mainly focusing on building position in high margin products. WITHIN four year of its establishment, arcelor has not only crossed its targets but also bolstered its position in the fieldof production and supply of high value-added steel. It became the lead supplier of steel to the automotive, house appliances, construction, packaging sector and general industries. It has strengthened its position in carbon steel,especially more so in automotive steel. The key strategy of arcelor in international development is to maintain balance between high growth emerging markets and supporting multinational clients. INDUSTRY BACKGROUND More than a hundred year old steel industries has grown strongly and steadily through the decades steel industry witnessed a significant restructuring in the last 15 years mainly due to decline in the demand from the central and eastern Europe. During the 1990s, the industry observed restructuring with the marked regional consolidation among European union producers. The saga of arcelor-mittal merger On January 27,2006 mittal stunned the global steel industry with the launch of a surprise bid for its nearest rival arcelor with an unsolicited offer of euro18.6bn. mittal made an offer of 4 mittal shares plus 35.25cashfor every five shares of arcelor. The alternative offer were stock offer of 16 mittal shares for 15 arcelor shares or cash offer 28.21 for each arcelor share and the proration of aggregate consideration was 25%cash and 75% stock. Mittal kept few conditions in his offer that there should be a minimum accepted of more than 50%and also no change in the arcelor substance during the offer. In addition to these condition, mittal also wanted to sell dofasco to thyssenkrupp for 3.8 bn. Mittal was ready to reimburse the payment of break fee by arcelor to dofasco and the earning of dofasco before its sale will be transferred to the combined group. The latest bid offers 13Mittal shares plus 150.6 cash for 12 Arcelor share with an option to recive more cash or shares subject to 13 % cash and 69% stock in aggregate. However ,both the companies have not yet come to a consent regarding Canadian steel maker Dafosco that arcelor acquired in January 2006. Under the agreement, the marged firm will be called Arcelor Mittal . Arcelir investors

retain 50.5% ownership . Mittal family, which held875 share capital and a lock-upperod of five years, subject to certain exceptions. Regardless of holding period, all the shareholders will have identical voting and economic rights,i.e. one vote for one share. Kinsch of arcelor will becom the chairman and LN Mittal will be the president of the arcelor Mittal wherein, LN Mittal will be from Mittal Steel, three representatives of Arcelor shareholders and three representatives of employees. After three years, the shareholders will be elacting thair Bord of directors. The management board will be comprised of seven executive among which, four executives will be from Arcelor, three executives will be frome Mittle Steel and the chairman of the new company will propose the CEO. The Best Combination Arcor is the number one steel number one steel company by revenue whereas Mittal is the number one steel company in terms of shipments . the combination of thease two top companies leades the consoldination to new to new level making Arcelor Mittal as the Numero Uno. The combaind company will immediatelyachive industry ledership by dwarfing other steel makers with the production capacity of over 120 million tons ayear whish is approximately 10% of globle steel production . It will produse three times more than capitalization of $46 bn. The new company with ites 61 plantes in 27 countries will lead the major markets like North America , South America, Western Europe,Estern Europe and Africa. Mittal Steel and Arcelor are quite complimentary in their business leading to a minimal overlap in geographic and product fit.In the US Mittal steel is the leading supplier to the packaing, appliances and automotive sector with strong R&D and in the European market arcelor enjoys the similar position . Mittal Steels mills produse lower-quality steel that is generally sold in open market while Arcelor focuse on high-quality steel for long-term costomers. Conclusion From the above project we conclude that: The merger of Mittal Steeland Arclor is bound to bring a steel change in the consolidation of steel industry. The combination is expected to offer unparalleled scale of production coupled with strong globle presence, thus providing unigue platform for groth and value creation.

Q.6 What are the motives for a joint venture, explain with an example of a joint venture. Answer: Given below are the key motives behind the joint ventures: To augment insufficient financial or technical ability to enter a particular line or business. To share technology & generic management skills in organization, planning & control. To diversify risk To obtain distribution channels or raw materials supply To achieve economies of scale To extend activities with smaller investment than if done independently To take advantage of favorable tax treatment or political incentives (particularly in foreign ventures). Joint ventures are new enterprises owned by two or more participants. They are typically formed for special purposes for a limited duration. It is a combination of subsets of assets contributed by two (or more) business entities for a specific business purpose and a limited duration. Each of the venture partners continues to exist as a separate firm, and the joint venture represents a new business enterprise. It is a contract to work together for a period of time each participant expects to gain from the activity but also must make a contribution. For example: GM-Toyota JV: GM hoped to gain new experience in the management techniques of the Japanese in building high-quality, low-cost compact & subcompact cars. Whereas, Toyota was seeking to learn from the management traditions that had made GE the no. 1 auto producer in the world and In addition to learn how to operate an auto company in the environment under the conditions in the US, dealing with contractors, suppliers, and workers. DCM group and Daewoo motors entered in to JV to form DCM DAEWOO Ltd. to manufacture automobiles in India. *********