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Mergers and acquisitions

CA Sagar Khubchandani 
Updated on 01 August 2020

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Mother Teresa once quoted, "I can do things you cannot, you can do things I cannot; together we can do great things."

Collaboration brings more benefit in everyday life than what a person alone can achieve. Business world is no different. To enhance more advantages, organizations go for mergers and acquisition as a means for efficient and quick growth.

Meaning

Mergers and Acquisitions (M&A) is a term normally referring to consolidation of companies. However, from legal point of view, acquisition means taking over of another company (target company) thereby making it as a new owner of the target company. Merger, on the other hand, is consolidation of two (or more) entities into a single entity and neither of the previous companies remain independent.

Why M&A?

An ant needs to carry out lot of effort to pick a crystal of sugar. But, when more number of ants join hands, it requires less effort to carry a crystal and henceforth they can reap benefit of so many crystals with shared efforts.

That's what happens in merger and acquisition. Reaping more benefits with shared efforts.

Major motive is to enhance performance and reduce risk.

Synergy: Enhanced operations due to combined entities can help to avail bulk purchasing discount. Also, there can be shared knowledge of resources of different entities to maximise return.

Economies of scale : Removing duplicate departments or operations can reduce overall fixed cost against the same revenue stream, thereby increasing the overall profit margin.

Economies of scope: Company can improve its customer/client's base. It can meet demand over wide geographical regions through efficient marketing and distribution.

Market share: Generally companies absorb or merge with its competitor in the market. This helps to capture larger chunk of market share with combined entities.

Taxation: At times, companies absorb loss making units so that they can claim set off of losses of target company against the profits of acquirer company as allowed by Income Tax Act.

Not to rule out the fact that at times, acquisitions don't stand upto the expectations due to dynamic and unpredictable business environment. Acquisition success becomes bit difficult with studies showing 50% probability of success of an acquisition. Acquisition is very complex, with many dimensions influencing its outcome.

Types of M&A

Horizontal merger: It is generally between two companies in the same sector. Example can be purchase of a firm in automobile sector by a firm of automobile sector to gain dominant market share.

Vertical merger: It is combination of firms in different stage of production of the same sector like buying supplier of a business to reduce overall cost. Example can be automobile company buying spare parts supplier company.

Conglomerate: Combination of firms in unrelated lines of business activity. Example can be automobile company acquiring company in electronic industry.

Arms length merger: Arm's length merger is a merger

1. Approved by disinterested directors and

2. Approved by disinterested shareholders

Strategic merger : It refers to long term strategic holding of target firm. This type of M&A aims at creating synergies in the long run by increased market share, broad customer base and corporate business strength. A strategic acquirer may also be willing to offer premium to target firm in the outlook of the synergy value created after M&A process.

Acqui-hire: It involves buying target firm's talent rather than their products. They are then discontinued as part of acquisition so that team can focus on new projects for their new employer. Facebook, Twitter and Yahoo have recently used this form of acquisition to add expertise in particular areas to their workforce.

Important steps in the M&A process

a. Planning: It will require the analysis of information on firms and industry. The acquiring firm should keep in mind its objective of acquisition in the context of its strengths and weaknesses .Industry data on market growth, nature of competition, ease of entry, capital and labour intensity, regulations, etc can help a company to formulate a strategy suitable to its needs.

b. Search and screening: This process involves searching for suitable firms for acquisition as per its formulated strategy. Identified firms are then shortlisted and detailed information about each of them is obtained.

c. Business valuation: It involves present and future valuation of target company. It takes into account various factors such as profits and cash flow pattern, capital gain, organisation structure, market share, business strengths, weaknesses reputation, etc of the target company.

d. Proposal: A proposal is sent to target company in the form of letter of intent or a non-binding offer document. It contains complete details about the deal including strategies, amount and the commitments.

e. Integration: This stage includes both the companies coming together with their own parameters. It includes the entire process of negotiating, making documents and signing the agreement.

f. Operating the venture : After signing the agreement and entering into the venture, operations are put to use to meet the set and predefined objectives.

M&A process has to comply with regulations of Companies Act, Competition Act, Foreign Exchange Management Act, Income Tax Act and SEBI regulations.

Business valuation

Valuation of business is most important aspect of M&A as valuation will have major impact on the price for which business will be sold off.

Five most common ways to value business are:

1. Asset valuation
2. Historical earnings valuation
3. Future maintainable earnings valuation
4. Relative valuation (comparable companies and comparable transactions)
5. Discounted cash flow (DCF) valuation

Professionals who value business generally use combination of these methods or some other methods not mentioned here as per their suitability. As synergy plays vital role in valuation of acquisition, it is paramount to get value of synergies right. They are in addition to the sale price of the firm as it would mean more benefit to the acquirer.

Value of synergy = Combined value - (Value of acquirer company + Value of target company)

Recent mergers

Flipkart-Myntra: The huge and most talked about acquisition of the year. The seven year old Bangalore based domestic e-retailer acquired the online fashion portal for an undisclosed amount in May 2014.Industry analysts and insiders believe it was a $300 million or Rs 2,000 crore deal.

RIL-Network18 Media and Investment: Reliance Industries Ltd (RIL) took over 78% shares in Network 18 in May 2014 for Rs 4,000 crore. Network 18 was founded by Raghav Bahl and includes moneycontrol.com, IN.com, IBNLive.com, Firstpost.com, Cricketnext.in, Homeshop18.com, Bookmyshow.com, while TV18 group includes CNBC TV18,CNN IBN, Colours, IBN7 and CNBC Awaaz.

Merk-Sigma deal: One of the leading India manufacturers, Merk KGaA took over US based Sigma Aldrich company for $17 Billion in cash. Sigma is the leading supplier of organic chemicals and biochemical to research laboratories and supplies groups like Pfizer,Novarties with lab substances.

Ranbaxy-Sun Pharma deal: Sun Pharma Industries Ltd, a multinational pharmaceutical company headquartered in Mumbai, Maharashtra which manufactures and sell pharmaceutical formulations and active pharmaceutical Ingredients (API) primarily in India and US bought Ranbaxy Laboratories. Ranbaxy shareholders will get 4 shares of Sun Pharma for every 5 shares held by them.

The deal, worth $4 Billion will lead to a 16.4% dilution in the equity capital of Sun Pharma.

Nutshell

A well planned and duly diligent merger or acquisition can create a very strong foundation for business that can help them reap fruits in the long run that a company alone could not reap.

Thus, it is advisable to do immense research in the industry while selecting the right firm and executing the operations that would maximise the return to both the companies.

The author can also be reached at khubchandani_sagar@yahoo.com


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