Case Analysis –

Mergers and Acquisition

World Enterprises and Wheelrim
and Axle Company
Submitted By:-
Amanjot Bhullar
Dheeraj Aggarwal
Maninder Pal Singh
Pardeep Dahiya
Sanchit Agarwal
Simaranjit Tiwana
Vishvasniya Rathee
Introduction

• Given case is a classic example of “Bootstrap effect” of a merger between

World Enterprises and Wheelrim and Axle Company. World Enterprises
wants to enter into the merger just to have a temporary boost in its EPS
without any other strategic real gains.

• Merger is a tool used by companies for the purpose of expanding their

operations often aiming at an increase of their long term profitability.

• But in the given case, it is assumed that there are no real gains from the
merger.

“One of the largest, most critical, and most difficult parts of a business merger
is the successful integration of the enterprise networks of the merger
partners.”
Some key Definitions
Takeover
▫ The transfer of control from one ownership group to another.
Acquisition
▫ The purchase of one firm by another so that ownership transfers
There is no tangible difference between an acquisition and a takeover;
both words can be used interchangeably - the only difference is that
each word carries a slightly different connotation. Typically, takeover is
used to reference a hostile takeover where the company being
acquired is resisting. In contrast, acquisition is frequently used to
describe more friendly acquisitions, or used in conjunction with the
word merger, where both companies are willing to join together.
Merger
▫ The combination of two firms into a new legal entity.
▫ A new company is created.
▫ Both sets of shareholders have to approve the transaction.
Key Definitions …Continued
• Merger through Absorption: An absorption is a combination of two or more
companies into an 'existing company'. All companies except one lose their
identity in such a merger.
▫ For example, absorption of Tata Fertilisers Ltd (TFL) by Tata Chemicals Ltd. (TCL).
TCL, an acquiring company (a buyer), survived after merger while TFL, an acquired
company (a seller), ceased to exist. TFL transferred its assets, liabilities and shares
to TCL.

• Merger through Consolidation: A consolidation is a combination of two or

more companies into a 'new company'. In this form of merger, all companies
are legally dissolved and a new entity is created. Here, the acquired company
transfers its assets, liabilities and shares to the acquiring company for cash or
exchange of shares.
▫ For example, merger of Hindustan Computers Ltd, Hindustan Instruments Ltd,
Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new
company called HCL Ltd.
Types of Mergers

Horizontal
• A merger in which two firms in the same industry combine.
• Often in an attempt to achieve economies of scale and/or scope.

EXAMPLE- The amalgamation of Daimler-Benz and Chrysler is a popular

example of a horizontal merger.

Vertical
• A merger in which one firm acquires a supplier or another firm that is
closer to its existing customers.
• Often in an attempt to control supply or distribution channels.

EXAMPLE- An example of a vertical merger is a car manufacturer

purchasing a tire company.
Types of Mergers
Conglomerate
• A merger in which two firms in unrelated businesses combine.
• Purpose is often to ‘diversify’ the company by combining uncorrelated
assets and income streams.
• Conglomerate are much less popular now.

EXAMPLES- One example of a conglomerate merger was the merger

between the Walt Disney Company and the American Broadcasting
Company.

Cross-border (International)
• A merger or acquisition involving a domestic and a foreign firm a either
the acquiring or target company.

• EXAMPLE -takeover of Zain Africa by Bharti Airtel, Vedanta Resources

acquiring Cairn India from Cairn Energy and of course the latest -- Sun
Pharma acquiring Israel's Taro
Reasons for Mergers and Acquisitions
• Capacity
• Capacity refers to the amount of output that a firm is capable of producing given its
existing assets. Acquiring another business might enable it to be able to increase its
capacity relatively quickly.

• Economies of Scale
• Economies of scale are the advantage of large scale production that result in lower
cost per unit produced.

• Accessing technology or skills

• A firm may be targeted for acquisition because it has specific skills within its staff or
has a particular technology that would be useful to another business.

• Tax reasons
• Businesses are always looking for ways to reduce their tax exposure. A firm has large
sums of money lying idle, using these sums to acquire another business that would
not only enhance its operations but would also reduce its tax liability
Reasons for Failure of Mergers and Acquisitions
Size Issues
A mismatch in the size between acquirer and target has been found to
lead to poor acquisition performance. Many acquisitions fail either
because of 'acquisition indigestion' through buying too big targets or
failed to give the smaller acquisitions the time and attention it required
Lack of Research
Acquisition requires gathering a lot of data and information and analyzing
it. It requires extensive research. A carelessly carried out research about
the acquisition causes the destruction of acquirer's wealth
Diversification
Very few firms have the ability to successfully manage the diversified
businesses. Unrelated diversification has been associated with lower
financial performance, lower capital productivity and a higher degree of
variance in performance.
Recent Mergers and acquisitions

Reliance Industries in March 2009

approved a scheme of
amalgamation of its subsidiary
Reliance Petroleum with the parent
company. The all-share merger
deal between the two Mukesh
Ambani group firms was valued at
about Rs 8,500 crore ($1.68 billion).
This makes it India's 11th largest
Mergers and Acquisitions
transaction till date.
HDFC Bank-Centurion Bank of
Punjab: $2.4 billion
HDFC Bank approved the acquisition
of Centurion Bank of Punjab for Rs
9,510 crore ($2.4 billion) in one of the
largest mergers in the financial sector
in India in February, 2008. Centurion
Bank of Punjab shareholders got one
share of HDFC Bank for every 29
shares held by them. Post-acquisition,
HDFC Bank became the second-
largest private sector bank in India.
The acquisition was also India's 7th
largest ever.
Boot Strap Effect
• “Bootstrap” or “Chain Letter” is referred to
generating earnings growth from purchase of slowly
growing firms with low price earnings ratio instead
of earnings growth due to capital investments or
improved profitability.
• When there is no real gain created by the merger
and no increase in the two firm’s combined value.
Merger Gain= PVab - (Pva + PV ) =
b PV ab
Key Assumptions

• Merger between the given firms will produce no

economic benefit or real gain, hence the firms
should be worth exactly the same together as they
are apart
• There is no revaluation of firm by investors, so the
market value of World Enterprises after merger is
the sum of separate values of the two firms
Q.1 Complete the table

Particulars World Wheelrim and Merged firm

Enterprises Axle
Earnings per $2.00 $2.50 $2.67
share
Price per share $40 $25 $34.3

Price earning ratio 20 10 12.84

Number of shares 100,000 200,000 262,172

Total earnings $200,000 $500,000 $700,000

Total market value $4,000,000 $5,000,000 $9,000,000

Working Notes – Market Value and Total Earnings
Calculations

• Total market value of merged firm

= Market value of World enterprises + Market
value of Wheel rim and Axle
= 4,000,000 + 5,000,000
= $9,000,000

• Total earnings of merged firm

= Earnings of world enterprises + earnings of
Wheelrim and Axle
= $200,000 + $ 500,000
= $700,000
Working Notes – Number of Shares and Price Per
Share

• Number of shares
= Earnings of merged firm/Earnings per share
= 700,000/2.67
= 262,172

• Price per share

= Total market value/Number of shares
= 9,000,000/262,172
= 34.33
Working Notes – P/E Ratio Calculation

• Price-earnings ratio
= Price per share/ Earnings per share
= 34.33/2.67
= 12.86
Q.2 How many shares of World enterprises are
exchanged for each share of Wheelrim and Axle?

• Total shares offered by World enterprises to acquire

Wheelrim and Axle
= Number of shares of merged firm – Number
of shares of World enterprises before merger
= 262,172 – 100,000
= 162,172
• Shares exchanged for each share of Wheelrim and
Axle
= 162,172/200,000
= 0.81
Q.3 What is the cost of merger to World Enterprises

• Cost of merger
= Shares offered * Market value of shares
after merger – Market value of acquired firm
= 162,172*$34.33 – $5,000,000
= $567,364.76
Q.4 What is the change in the total market value of
the world enterprise shares that were outstanding
before the merger
• Market value of given shares before merger
= $4,000,000
• Market value of given shares after merger
= Number of shares * Price per share
= 100,000*34.33
= $3,433,000
• Therefore, change in market value
= 3,433,000-4,000,000
= $(567000)
Conclusion

• If the given deal, a characteristic example of

Bootstrap effect, is able to fool the investors, then
the financial manager may be able to puff up the
stock price artificially.
• But it will happen only on the temporary basis, or
the firm has to continue to expand via merger at
the same compound rate.
• Obviously this cannot go forever, and at the point
where it stops or slows down, the earnings growth
will fall dramatically.