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July-October 2007 Volume 2 Issue I1 www.iipmthinktank.com<br />
SPECIAL ISSUE<br />
MERGERS & ACQUISITIONS<br />
INDIA INC. GOING<br />
GLOBAL<br />
Rs. 100<br />
AN <strong>IIPM</strong> THINK TANK PUBLICATION<br />
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M A K E W E A L T H W H I L E O T H E R S T H I N K O F I T<br />
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NEED THE DOUGH<br />
July-October - 2007 Volume 2 Issue II www.iipmthinktank.com<br />
PANORAMA<br />
TRENDS<br />
8 A“M&A”ZING INDIA<br />
By Mr. Mohammed Zakriya<br />
and Prof. Tareque Laskar,<br />
<strong>IIPM</strong> <strong>Think</strong> <strong>Tank</strong>, Mangalore<br />
It is not easy to gauge the synergy created<br />
between the acquirer and the target based on<br />
the fi nancial performance ...<br />
12 Mergers and Acquisitions :<br />
Get the Basics Right<br />
By Ms. Bhuvna Ravi<br />
Director, Abhay Capital Services Pvt. Ltd.<br />
<strong>The</strong> restrictions on M&A transactions in India<br />
have been substantially relaxed with the<br />
liberalisation of the economy ...<br />
16 A Critical Assessment of the<br />
Merger and Acquisitions<br />
Scenario in India<br />
By Prof. K. P. Ramakrishnan, Visiting faculty,<br />
<strong>IIPM</strong>, New Delhi<br />
Due to the existence of strict government<br />
regulations, Indian companies were forced to<br />
move into new areas ...<br />
20<br />
A BIG RICH<br />
INDIAN WEDDING:<br />
MERGERS REVISITED<br />
24 Jet Airways – Air Sahara<br />
“Lite” at the end of the<br />
Tunnel<br />
By Prof. Prashant Gupta and Dr. Kapil Pandla,<br />
Jaipuria Institute of Management, Noida<br />
If completed, the merger would have<br />
created the largest Indian airline with<br />
control over nearly half the market...<br />
28 <strong>The</strong> Surging Tsunami -<br />
Mergers & Acquisitions<br />
Story…<br />
By Ms. Sudha Rajagopal, Ex-Banker<br />
<br />
<br />
M & A deals are done to derive a greater<br />
benefit from the merged entity rather<br />
than from the individual bits...<br />
34 M & As Calling: Indian Inc.<br />
on a Buying Binge<br />
By Mr. Shashank Tripathi, Research Associate,<br />
Planman Media<br />
38<br />
IN FOCUS<br />
42<br />
M&A<br />
in the<br />
INDIAN BANKING<br />
INDUSTRY
RESEARCH<br />
52 Mergers and Acquisitions in<br />
Emerging Economies:<br />
A Study of Impact on Scale<br />
Economies, Technological<br />
Change and Structural Shift in<br />
Profitability<br />
By Dr. Chandra Shekhar Sharma, Reader, Shri Ram<br />
College of Commerce, University of Delhi<br />
<strong>The</strong> theoretical foundation rests on the assertion<br />
that in effi cient markets, market value and stock<br />
registers changes around merger announcements<br />
to fully capture and refl ect the economic gains<br />
from the merger…<br />
INDIA INC. GOING<br />
G L O B A L<br />
<br />
SPECIAL ISSUE<br />
MERGERS &<br />
ACQUISITIONS<br />
46<br />
64 ‘Strategic Objectives behind<br />
Corporate Acquisitions &<br />
the Impact of <strong>The</strong>se Acquisitions<br />
on Shareholders Wealth’<br />
By Mr. Parth Sarathi,Fellow Student, <strong>IIPM</strong>, New Delhi<br />
70<br />
Researchers believe that the fi rm’s ability to<br />
achieve a sustainable competitive advantage<br />
depends upon its relative cost and differentiation<br />
positions...<br />
PRIVATE<br />
EQUITY RAIL<br />
BACKING<br />
M & A<br />
TRAIL<br />
By Mr. Ashwani Batra,<br />
Senior Analyst,<br />
Global Strategy &<br />
Investment Consulting,<br />
Planman Consulting (India)<br />
Pvt. Ltd.<br />
78<br />
M&A<br />
DUE DILIGENCE<br />
MORE THAN<br />
JUST FINANCIAL<br />
By Mr. Supriya Mitra Majumdar, Planman Technologies (India) Pvt. Ltd.<br />
Consolidation<br />
Corporate<br />
Activities–Indian Perspective
Editor’s Page<br />
Dear reader,<br />
Prasoon S. Majumdar<br />
Over the years, in each of the graduating class, interestingly I fi nd more and more students opting for fi nance<br />
as their specialization. On further probing, I realize that of the students who opt for fi nance, most of them<br />
want to make a career in lucrative investment banking services. <strong>The</strong> reasons are quite evident though, as over<br />
the years as more and more Indian companies are strengthening their <strong>global</strong> footholds through mergers and<br />
acquisitions (M&A), the job of an investment banker is getting even more exciting and rewarding.<br />
In fact the transition had been quite interesting, as in 1991, when the then Finance Minister Dr. Manmohan<br />
Singh took to economic reforms, India Inc. was up it sleeves as they believed that <strong>global</strong> corporations would<br />
threaten their ‘cushioned’ existence through deep pockets and superior technology. But, ten years down, the<br />
way the India companies, in a generic fashion have gone ahead in terms of buying <strong>global</strong> companies, as if there<br />
is no tomorrow. In 2001, a tiny step that India Inc. took in terms of outbound deals worth USD 0.7 billion has<br />
eventually swollen to a staggering USD 15 billion by 2006. In fact during January-May 2007, the total M&A<br />
deals were worth USD 47.37 billion, of which the cross border deals were worth USD 28.19 billion. Though<br />
currently, in relative terms India is still a baby in terms of the total <strong>global</strong> M&A market (which has been around<br />
USD 2.7 trillion, for the same period), but then the manner things are proceeding, in no time it is <strong>going</strong> to be<br />
a formidable player in the <strong>global</strong> scene.<br />
In fact at our business school, we teach that management is all about people and the art of fi nding people<br />
at the right places and to see to it that they are taken care, for success and failure of any corporation is in<br />
its people. Interestingly, the same is observed in the case of <strong>global</strong> mergers and acquisitions too. It is a well<br />
known fact now that almost 70% of mergers fail because of people/cultural issues, yet intriguingly even today<br />
M&A deals are restricted to the domains of corporate lawyers, strategists, merchant bankers and fi nancial<br />
analysts, and for the human resource team, no where to be seen. Globally, it is almost like an implicit practice<br />
that whenever it comes to any M&A deal focus is invariably on the fi nancial and business issues and a host of<br />
other strategic issues, except for human issues. How much so ever fi rms try to justify the failed merger through<br />
strategic of fi nancial reasons or in terms of myriad economic rationalities, the truth is that there are certain<br />
softer and fi ner human facets involved invariably, which no rationality can justify. To come to the point, the<br />
familiar problem among the M&A failures is decisive disregard of human factor but the explanation varies<br />
across the economies dependent upon cultural, political and economic variability. And the irony is that in<br />
spite of the historical evidence of recorded failures of M&As on several planes, many M&As have taken place<br />
in the recent decades with blatant disregard for human capital (barring the factual information and legal<br />
backgrounder).<br />
So as more and more Indian fi rms buy out <strong>global</strong> counterparts and as more and more of my students take up<br />
investment banking as their career in course of the great Indian merger movement, they should remember<br />
that buying out corporations is nothing else but directing people’s lives and their associated dreams and<br />
aspirations! If it is people who create world class organizations, nothing could be more strategic than their<br />
happy existence, and for every other business rationalities, they can follow. In absence of this, every deal would<br />
remain a failed deal, for people management complements strategy and processes.<br />
Best<br />
Prasoon S. Majumdar<br />
(As appeared in ”<strong>The</strong> Sunday Indian”)
<strong>The</strong> India Economy Review June - 2005 7
PANORAMA<br />
A“M&A”ZING<br />
INDIA<br />
<br />
<br />
<br />
8 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
“We are slowly but surely moving from a regime of “large number of<br />
small banks” to “small number of large banks.” <strong>The</strong> new era is <strong>going</strong> to<br />
be one of consolidation around identified core competencies. Mergers and<br />
acquisitions in the sector are <strong>going</strong> to be the order of the day”<br />
–Excerpt from speech by Mr. V Leeladhar, Deputy Governor of the Reserve Bank of India, to Kanara<br />
Chamber of Commerce and Industry, Mangalore (March 11, 2005)<br />
Mergers and acquisitions activity is heating up<br />
in India at par with its counterparts across<br />
the globe as the Indian companies go on a<br />
buyout rampage as a means to strengthen their <strong>global</strong><br />
footprints. This acquisition spree by Indian companies,<br />
though as not fervent as Chinese, has still been a<br />
major contributor to the Mergers and Acquisition activity<br />
across the continents. <strong>The</strong><br />
fact being significant here is that<br />
most of the Chinese acquirers are<br />
Government-owned, while acquisition<br />
by Indian Companies<br />
are notably private initiatives.<br />
And, what might be the reason<br />
for relatively high Indian interest<br />
in the buyouts and takeovers<br />
Simply put, the annual turnover<br />
of companies in India has been<br />
rising at a steady pace of about 25-30% in last 5-6 years,<br />
which adds up to the profitability of the companies and<br />
enviable reserves. With copious cash reserves under<br />
their bellies, the ideal expansion strategy for Indian<br />
corporations (especially for the large ones like Infosys,<br />
Tata and Reliance) is to expand <strong>global</strong>ly to meet their<br />
hunger for control, growth and diversification. Before<br />
we proceed further in this direction, let’s fi rst have a<br />
quick recap at the evolution and growth of Mergers and<br />
Acquisitions activities in India over past few years.<br />
Recap:<br />
<strong>The</strong> Indian economy has undergone a major transformation<br />
and structural change during the past decade<br />
or so as a result of economic reforms introduced by the<br />
Government of India (since 1991) in the wake of policy<br />
of economic liberalization and <strong>global</strong>ization. In this<br />
liberalized era, size and “core competence” have become<br />
the focus of every business enterprise. Naturally, this<br />
requires companies to grow and expand in businesses<br />
or processes that they understand well. Thus, leading<br />
corporate houses have undertaken massive restructuring<br />
exercises (M and A being one of them) to create a<br />
formidable presence in their core areas of interest. <strong>The</strong><br />
corporate sector increasingly resorted to Mergers and<br />
Acquisitions due to significant gains they entail in terms<br />
of synergy, economies of scale, better fi nancial and marketing<br />
advantages, diversification and reduced earnings<br />
volatility, improved inventory<br />
management, increase in domestic<br />
market share, and above<br />
all capturing fast growing<br />
markets abroad. Since such a<br />
restructuring exercise should<br />
promote fair competition for<br />
the overall benefits of shareholders<br />
and consumers, regulations<br />
were thought to be necessary<br />
to govern this exercise.<br />
<strong>The</strong> SEBI, therefore, notified the, ’Takeover Code in<br />
February 1997, which laid down the rules, which govern<br />
corporate takeovers in India’.<br />
Initially, it was necessity that compelled Indian Companies<br />
to venture into industries abroad, when companies<br />
like Oil and Natural Gas Corporation embarked<br />
on the acquisition journey so as to meet their demands<br />
by securing Oil fields. But, the motives of mergers and<br />
acquisitions have changed over time ranging from monopoly<br />
of Technological Expertise, Control over the<br />
entire Value Chain to mere diversification to increase<br />
the risk spread in this era of <strong>global</strong>ization. <strong>The</strong> second<br />
wave of M and A activity represented general consensus<br />
towards M and A being a good means of consolidation.<br />
<strong>The</strong> steel giants, communication sector and Sahara-Jet<br />
deal being the highlight of this wave which is <strong>going</strong> to<br />
continue for some more time in the coming months.<br />
And very soon, what might capture the Markets, as I see,<br />
would be a third wave impelled by the need to grow and<br />
diversify which will be impelled largely by the Services<br />
and Real Estate/Infrastructure sectors.<br />
Mergers and acquisitions<br />
activity is heating up<br />
in India at par with its<br />
counterparts across the<br />
globe<br />
July-October - 2007 Need the Dough<br />
9
PANORAMA<br />
<strong>The</strong> year gone by has seen heavy business activity in<br />
the mergers and acquisition segment, a few of which has<br />
already been mentioned above. Consulting fi rms made<br />
huge money out of this, irrespective of the fact that it<br />
created value or synergies for its client. Some acquisitions<br />
saw destruction of shareholder value but most<br />
of them were successful.<br />
It is not easy to gauge the<br />
synergy created between<br />
the acquirer and the target<br />
based on the fi nancial performance<br />
or balance sheet<br />
values. <strong>The</strong> synergies created<br />
are seen only after<br />
three years of the takeover<br />
process where the target<br />
fi rm settles down in the culture of the acquirer.<br />
And Now:<br />
<strong>The</strong> trends in market suggest that outbound investments<br />
from India will mainly be in oil, pharmaceutical, automotives<br />
and service sector, while the inflow of investments<br />
are expected in emerging sectors such as retail,<br />
telecommunication, infrastructure and real estate as the<br />
state opens up for the foreign investments. Inbound<br />
investments in infrastructure, real estate, retail, and<br />
logistics have started emerging. India’s M&A environment<br />
is vibrant due to positive regulatory mechanisms,<br />
<strong>global</strong>ly accepted business processes, and a robust and<br />
optimistic investment climate. In the recent policy announcement,<br />
the State has given capital subsidy of 25<br />
percent on investments for setting up semiconductor<br />
and nano-technology manufacturing units. This will<br />
probably further fuel cross-border M&A deals in the<br />
electronics industry. According to Investment bankers,<br />
Merger & Acquisition (M & A) deals in India will cross<br />
$100 billion this year, which is double last year’s level<br />
and quadruple of 2005. (Source: High Tide of Mergers<br />
and Acquisitions in India – ARC Advisory group<br />
- By Sharada Prahladrao). This mark is bound to be<br />
surpassed by a considerable margin; given the fact that<br />
the total equity deals struck by Indian companies have<br />
crossed 50 billion USD in fi rst five months of 2007. In<br />
the same timeframe last year the equity deals stood at<br />
13.5 billion USD (as per ICICI bank’s private research<br />
division in their Global Investment Outlook report).<br />
If we look at the biggest M and A deal of last year, it<br />
has to be merger of AT&T and BellSouth (valued at<br />
around $73 Billion) where as the topmost takeover/<br />
merger deal by an Indian company was by the world’s<br />
biggest steelmaker, Mittal when he achieved success in<br />
buying all the shares of its top competitor, Arcelor of<br />
10 Need the Dough July-October - 2007<br />
It is not easy to gauge<br />
the synergy created<br />
between the acquirer and<br />
the target based on the<br />
financial performance<br />
Luxembourg (at $33 Billion). This year Tata Steel kept<br />
the consolidation wave high in the steel sector with the<br />
acquisition of Anglo Dutch fi rm- Corus- in a $10 Billion<br />
deal to form the fifth largest steel-producing entity in<br />
the world (with Arcelor-Mittal leading the race by far).<br />
In recent times, there have been speculations flying<br />
high about the Indian market being<br />
ripe for another mega Merger deal.<br />
This has brought out reports of a<br />
proposed takeover of Capgemini<br />
(the European outsourcing giant)<br />
by Indian top software outsourcing<br />
company Infosys. To bring out the<br />
disparity in the size and extent of<br />
each of these companies, we can<br />
see that even though Capgemini<br />
has a turnover of $10.35 billion compared to Infy’s $3.1<br />
billion, the strength that Infy carries is in its Market<br />
capitalization which lies at $27 billion (while Capgemini<br />
has capitalization of $10.4 billion). Such a high (almost<br />
thrice) capitalization, regardless of company turnover<br />
expanse, is what contributes to the high cash reserves<br />
in the company and hence the need to expand the operations.<br />
In spite of these reports being mere speculations,<br />
it has had a positive impact on the share prices of<br />
Capgemini, which in turn just signifies how a proposed<br />
takeover/acquisition can benefit the acquiree through<br />
value creation.<br />
In 2001, a tiny step that India Inc. took in terms of outbound<br />
deals worth USD 0.7 billion has eventually swollen<br />
to a staggering USD 15 billion by 2006. In fact during<br />
January-May 2007, the total M&A deals were worth USD<br />
47.37 billion, of which the cross border deals were worth<br />
USD 28.19 billion. Though currently, in relative terms<br />
India is still a baby in terms of the total <strong>global</strong> M&A<br />
market (which has been around USD 2.7 trillion, for the<br />
same period), but then the manner things are proceeding,<br />
in no time it is <strong>going</strong> to be a formidable player in the<br />
<strong>global</strong> scene.<br />
<br />
References:<br />
- High Tide of Mergers and Acquisitions in India<br />
– ARC Advisory group - By Sharada Prahladrao<br />
- India Inc embarks on an merger a acquisition spree<br />
- <strong>The</strong> Free Press Journal — December 29, 2004<br />
- Infosys’ Cap Gemini plan: Is it a saga of identity<br />
crisis -Krissy- June 30, 2007 (http://www.bpotiger.com/2007/06/infosys_cap_gemini_plan_is_<br />
it.html)<br />
- Contemporary and future issues in Indian banking<br />
– by V Leeladhar<br />
(http://www.bis.org/review/r050321g.pdf)
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PANORAMA<br />
MERGERS AND<br />
ACQUISITIONS :<br />
GET THE BASICS RIGHT<br />
Mergers and acquisitions<br />
are a common<br />
phenomenon in a<br />
competitive and free<br />
economy and as<br />
India integrates into<br />
the world economy,<br />
there will be several<br />
opportunities for<br />
M&As...<br />
<br />
<br />
<br />
Mergers and acquisitions are one of the tactics for continued growth in<br />
a highly charged <strong>global</strong> scenario. <strong>The</strong> consolidation integrates two<br />
organization to cut costs, reduces competition and consequently<br />
increases market share. Mergers and acquisitions are manifestations of an<br />
inorganic growth process.<br />
Mergers can be classified into three categories: when two entities amalgamate<br />
and give birth to a new entity; when a relatively small and less profitable<br />
company merges with a big company; when a relatively big and profitable<br />
company merges with a smaller company (sometimes even a loss-making<br />
company for that matter).While mergers can be defined to mean unification<br />
of two players into a single entity, acquisitions are situations where one player<br />
buys out the other to combine the bought entity with itself. <strong>The</strong> usual form<br />
of consideration for a merger is exchange of shares of the acquiring firm with<br />
the shares of the target company. In acquisitions, the consideration may take<br />
the form of cash consideration or loan instruments such as debentures. <strong>The</strong><br />
regulatory regime governing M&A is complex and straddles several areas of law<br />
and accounting, not to mention business concerns. <strong>The</strong> restrictions on M&A<br />
transactions in India have been substantially relaxed with the liberalisation of<br />
the economy. Thus, the provisions concerning M&A under the Monopolies<br />
and Restrictive Trade Practice Act, 1969 (MRTP) and the restrictions under<br />
12 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
Foreign Exchange Regulation Act, 1973 (FERA) have been<br />
substantially removed.<br />
In 1994, the law relating to acquisition of shares of quoted/listed<br />
companies was codified and the Securities and<br />
Exchange Board of India (SEBI) announced the Substantial<br />
Acquisition of Shares and Take over Code (the ‘code’). <strong>The</strong><br />
code inter alia provides that if any one or more persons<br />
together acquire 10 per cent or more equity shares of a listed<br />
company, the acquirer shall make an offer to the remaining<br />
shareholders of the company to acquire their shares. Indian<br />
Companies Act, 1956: This has provisions specifically dealing<br />
with the amalgamation of a company or certain other<br />
entities with similar status. <strong>The</strong> most common form of<br />
merger involves an elaborate but time-bound procedure<br />
under sections 391 to 394 of the Act. An amalgamation is<br />
complete only after the court sanctions it and it takes effect<br />
after the order of the court is filed with the Registrar of<br />
Companies TOP.<br />
Latest take over code of SEBI:<br />
For ensuring smooth takeovers,<br />
SEBI has designed the framework<br />
for listed companies from the taken<br />
over target companies, which is<br />
defined and detailed: Takeover is<br />
when “acquirer” takes the control<br />
by acquiring “substantial quantity of<br />
shares or voting rights” of the Target Company (where Target<br />
company: A Target company is a listed company whose<br />
shares are listed on any stock exchange and whose shares or<br />
voting rights are acquired/ being acquired or whose control<br />
is taken over/being taken over by an acquirer.)<br />
Acquirer: An Acquirer includes persons acting in concert<br />
(PAC) with the same i.e. any individual/company/any other<br />
legal entity which intends to acquire or acquires substantial<br />
quantity of shares or voting rights of target company<br />
or acquires or agrees to acquire control over the target<br />
company.<br />
Control:<br />
Control is the right to appoint either directly or indirectly or<br />
by virtue of agreements or in any other manner majority of<br />
directors on the Board of the target company or to control<br />
management or policy decisions affecting the target company.<br />
However, in case there are two or more persons in<br />
control over the target company then in that case of any one<br />
of the persons from such control shall neither be deemed<br />
to be in control of management nor to any change in the<br />
nature and quantum of control amongst them.<br />
<strong>The</strong> restrictions on<br />
M&A transactions<br />
in India have been<br />
substantially relaxed<br />
with the liberalisation<br />
of the economy<br />
been registered with SEBI before making a PA. PA is required<br />
to be made through the said MB. <strong>The</strong> acquirer is<br />
required to make the P.A within 4 working days of entering<br />
into an agreement to acquire shares or to decide how to<br />
acquire shares/ voting rights of Target Company or after<br />
any such change or changes that would result in change in<br />
control over the target company.<br />
In case of indirect acquisition or change in control, the<br />
PA is made by the acquirer within 3 months of consummation<br />
of such acquisition or change in control or restructuring<br />
of the parent company or control over the target<br />
company. <strong>The</strong> offer price in these cases is determined with<br />
reference to the date of the public announcement for the<br />
parent company and the date of the public announcement<br />
for acquisition of shares of the target company, whichever<br />
is higher, in accordance with the parameters mentioned in<br />
the Takeover Regulations Documentation which is a copy<br />
(hard and soft) of the PA and which<br />
is required to be submitted to SEBI<br />
simultaneously with the publication<br />
of the same in the newspapers.<br />
A draft letter of offer is required<br />
to be filed with SEBI within 14 days<br />
from the date of Public Announcement<br />
along with a filing fee of<br />
Rs.50,000/- per letter of offer (payable<br />
by Banker’s Cheque / Demand<br />
Draft). A due diligence certificate along with registration<br />
details as per SEBI circular no. RMB (G-1) series dated<br />
June 26, 1997 is also required to be filed together with the<br />
draft letter of offer.<br />
Letter of offer:<br />
<strong>The</strong> MB will incorporate in the letter of offer the comments<br />
made by SEBI and send it within 45 days from the<br />
date of PA the letter of offers along with the blank acceptance<br />
form, to all the shareholders whose names appear<br />
in the register of the company on the Specified Date. <strong>The</strong><br />
offer remains open for 30 days. <strong>The</strong> shareholders send<br />
their Share certificate(s) / related documents to registrar or<br />
Merchant banker as specified in the PA and letter of offer.<br />
<strong>The</strong> pays consider all those shareholders whose shares are<br />
accepted under the offer, within 30 days from the closure<br />
of offer.<br />
<strong>The</strong> offer once made cannot be withdrawn except in the<br />
under mentioned circumstances:<br />
Statutory approval(s) required have been refused;<br />
<strong>The</strong> sole acquirer has died a natural death;<br />
Circumstances wherein the board orders a withdrawal.<br />
Public announcements:<br />
<strong>The</strong> Acquirer appoints a Merchant Banker (MB) who has<br />
Safeguards incorporated in the takeover:<br />
<strong>The</strong> acquirer has to open an escrow account before making<br />
July-October - 2007 Need the Dough<br />
13
PANORAMA<br />
the Public Announcement, in the form of cash deposited<br />
with a scheduled commercial bank or bank guarantee in<br />
favor of the Merchant Banker or deposit of acceptable securities<br />
with appropriate margin with the Merchant Banker.<br />
<strong>The</strong> Merchant Banker is also required to confirm the firm’s<br />
financial arrangements. If the acquirer fails to make the payment<br />
then the MB has a right to forfeit the escrow account<br />
and distribute the proceeds in the following way.<br />
• 1/3 of amount to target company<br />
• 1/3 to regional SEs, for credit to investor protection<br />
fund etc.<br />
• 1/3 to be distributed on pro rata basis amongst the shareholders<br />
who have accepted the offer.<br />
<strong>The</strong> Merchant Banker sends back the rejected documents<br />
which are kept in the custody of the Registrar /<br />
Merchant Banker to the shareholder through Registered<br />
Post. Besides forfeiture of escrow account, SEBI can also<br />
initiate separate action against the acquirer which may<br />
include prosecution / barring the acquirer from entering<br />
the capital market for a specified period etc.<br />
Mandates:<br />
Reporting is mandatory according to the Regulation 3(4)<br />
in respect of acquisitions arising<br />
out of firm allotment in public issues,<br />
rights issues, inter-se transfer<br />
amongst group companies, relatives,<br />
promoters, acquirers and PACs, Indian<br />
promoters and foreign collaborators<br />
and transfer of shares from<br />
state level Financial Institutions to<br />
co-promoters of company.<br />
Time frame:<br />
<strong>The</strong> report is submitted to SEBI within 21 days from the<br />
date of acquisition / allotment with a fee of Rs. 10,000/-<br />
per report.<br />
Scope of M & A:<br />
Mergers and acquisitions are a common phenomenon in a<br />
competitive and free economy and as India integrates into<br />
the world economy, there will be several opportunities for<br />
M&A deals both inside and outside India. In the context<br />
of the liberalised environment, M&As are emerging as a<br />
major business for the financial community. <strong>The</strong>re are a<br />
host of factors propelling the Indian corporate sector to<br />
move towards the M&A arena, including existence of several<br />
domestic players seeking to consolidate their business<br />
by acquiring firms in their core areas and shedding their<br />
non-core businesses. This trend is further supported by<br />
the presence of several foreign firms, which are looking to<br />
14 Need the Dough July-October - 2007<br />
<strong>The</strong> recipe for getting<br />
a successful merger<br />
starts from deal<br />
making to merging of<br />
cultures<br />
buy their way into the Indian market by acquiring existing<br />
plants and capacities.<br />
Post merger effect:<br />
Despite the rules and regulations; scrupulous efforts, hardwork,<br />
money and time spent go down the drain as the<br />
corporate marriages fail. As per the recent survey only<br />
15% of mergers are successful. During the takeovers the<br />
executives diligently synergize assets, equipments, technology<br />
and strategies and neglect the complexity of the variant<br />
cultures as they overlook the people factor.<br />
Suggestions:<br />
<strong>The</strong> recipe for getting a successful merger starts from<br />
deal making to merging of cultures. In fact this is proven<br />
to have attributed to the success of the Roman Empire.<br />
As Nancy Rothbard, Management Professor at Wharton<br />
University cites, `Developing a culture that is adaptable<br />
- both to market conditions and to the firm’s leadership<br />
- will help a company survive and grow.<br />
<strong>The</strong> other growth strategies are:<br />
• Be upfront and share information about intentions, targets,<br />
benchmarks and the course of action. Establish<br />
a rapport by explaining the reason<br />
for imminent changes and letting the<br />
others to voice their views, concerns,<br />
queries and doubts.<br />
• Patiently diluting away the resistance<br />
of the members of the acquired<br />
company with frequent interaction<br />
and regular dialogue will go a long<br />
way in rebuilding trust and morale levels.<br />
• Leaders should let the individual companies retain<br />
their distinctive identity and learn to live with the differences.<br />
• <strong>The</strong>y can accommodate variances by organising “firms<br />
within the firm” rather than pushing for “one firm”. For<br />
instance, instead of wiping away Ben & Jerry’s (U.S. icecream<br />
manufacturer) unique essence and strength, Unilever<br />
took the unconventional route and reaped windfall<br />
gains from preserving and complementing the former’s<br />
divergent character.<br />
Finally, nothing sums it up better than what Chris<br />
Burand, President of consulting firm Burand & Associates<br />
said, `<strong>The</strong> merger of companies is very much like<br />
the joining together of different families to celebrate the<br />
holidays. Each family has its own traditions, and those<br />
traditions must be merged carefully and thoughtfully to<br />
ensure future harmony”. <strong>The</strong>n only two good companies<br />
will transform into one great company with a happily ever<br />
after culmination.
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AN ICMR AND 4Ps B&M SURVEY<br />
4Ps<br />
BUSINESS AND<br />
MARKETING
PANORAMA<br />
DERIVATIVES<br />
A Critical Assessment of the<br />
Merger and Acquisitions<br />
Scenario in India<br />
By Prof. K. P. Ramakrishnan,<br />
Visiting faculty,<br />
<strong>IIPM</strong>, New Delhi<br />
Mergers and Acquisitions Post Independence:<br />
Mergers and Acquisitions have played a very important role in bringing about<br />
transformation of the industrial sector in India post independence. <strong>The</strong> economic<br />
and political conditions during several years before and after independence gave<br />
a stimulus to the genesis of large scale Mergers and Acquisitions. <strong>The</strong> inflationary<br />
situation prevailing at that time enabled many Indian businesses to amass<br />
incomes by charging high prices and hoarding black money.<br />
This led to a wholesale infiltration of businessmen into the industry during<br />
those years which gave rise to frantic activities in the stock exchange because<br />
of the development of a craze to acquire control over industrial units in spite<br />
of the swollen prices of their shares persisting at that time. <strong>The</strong> practice of<br />
cornering shares in the open market and trafficking of managing agency rights<br />
with a view to acquiring control over the management of established and reputed<br />
companies had all come into relief prominently at the time. <strong>The</strong> net ef-<br />
16 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
fect of these practices, namely that of acquiring control over<br />
ownership of companies and of acquiring control over the<br />
managing agencies, was that a large number of businesses<br />
passed into the hands of the prominent industrial houses of<br />
the country. As it became clear that India would be gaining<br />
independence, the British managing agency houses gradually<br />
withdrew their stakes from the Indian corporate affairs and<br />
liquidated their holdings at rock bottom prices that were<br />
offered to them by the Indian business houses. Besides the<br />
transfer of managing agencies, there were a large number of<br />
cases of transfer of interest in individual industrial units from<br />
British to Indian hands. Further, at that time, it used to be<br />
the fashion amongst the Indian business houses, to obtain<br />
control of insurance companies for the purpose of utilizing<br />
their funds for acquiring substantial holdings in many such<br />
above mentioned companies.<br />
Mergers and Acquisitions after the dependence of the<br />
country:<br />
After Independence, in the period between 1951 and 1974, a<br />
series of governmental regulations were introduced for controlling<br />
the operations of large industrial organizations in<br />
the private sector. Such regulations considerably influenced<br />
the growth strategies as adopted by most companies at that<br />
time. Some of these prominent regulations were, the Industries<br />
Development and Regulation Act,<br />
1951, the Import Control Order, 1957-58,<br />
the Monopolies and Restrictive Trade<br />
Practices Act, 1969, and the Foreign Exchange<br />
Regulation Act, 1973.<br />
Due to the existence of such strict<br />
government regulations at that time,<br />
Indian companies were forced to move<br />
into new areas where capabilities were<br />
difficult to develop in the short run. In<br />
pursuit of this growth strategy, they often changed their organizational<br />
structures as well as their basic operating characteristics<br />
in order to meet the requirements of a diversified<br />
business portfolio.<br />
During the decade of the 1990s:<br />
<strong>The</strong> Merger and Acquisition scenario at this time changed a<br />
lot especially after the initiation of the liberalization process<br />
in the year 1991. <strong>The</strong> plethora of Government regulations in<br />
respect of the industrial growth and the growth in Merger<br />
and Acquisition segment were reduced considerably during<br />
that time. Besides, several other measures were also initiated<br />
by the Government which included delicensing, derservation,<br />
MRTP Act relaxation, liberalisation of policy towards foreign<br />
capital and technology, etc. all of which led to a phenomenal<br />
structural transformation of Indian industry. Such transformation<br />
provided a much needed thrust to the corporates to<br />
seek to grow and expand through an inorganic process of<br />
growth enveloping the implementation of appropriate Merger<br />
and Acquisition strategy at its helm.<br />
If the growth, presence and size registered by some of the<br />
principal corporate groups in India, at the time were to be<br />
analyzed, it would be seen that most of the industrial houses/<br />
groups had employed the merger and acquisition process in a<br />
strategic manner for growing and expanding their businesses.<br />
In fact business houses like that of R.P. Goenka (RPG), Vijay<br />
Mallya (UB), and Manu Chabria (MC) had all employed with<br />
the merger and acquisition strategy largely to grow aggressively.<br />
<strong>The</strong> Piramal group had also nearly grown by the merger<br />
and acquisition route. <strong>The</strong> Murugappa group in the South of<br />
India had also grown by adopting a similar strategy. Other<br />
companies down in the South which had grown similarly by<br />
adopting the M & A route included the Ranbaxy group, Sun<br />
Pharmaceuticals Limited, HLL, etc. Post-liberalisation several<br />
studies were made by various academicians to evaluate the<br />
M&A market in India. Some of these were by Beena (1998),<br />
Roy (1999), Kumar (2000), etc.<br />
Some of the factors behind the Merger and Acquisition<br />
Process as identified by these studies were the following:<br />
External Factors:<br />
Though, there had been a number of M & As undertaken in<br />
Due to the<br />
existence of strict<br />
government<br />
regulations, Indian<br />
companies were<br />
forced to move<br />
into new areas...<br />
the period after independence, the ‘Anti-Monopoly’ bias in<br />
the Government regulatory environment prevailing in the<br />
1960s and in the 1970s seriously impeded the merger and<br />
acquisition process. This did not however mean that M & A’s<br />
were uncommon during those regulatory regimes.<br />
Based on a study of trends in the merger activity from<br />
1974-75 to 1994-95, Beena (1998) found that there had been<br />
an acceleration in merger activity in the liberalized regime<br />
of the 1990s. <strong>The</strong> study also argued that a number of factors<br />
had triggered off the merger and acquisition wave during<br />
the 1990s consequent upon relaxation and removal of many<br />
legal restrictions as noted above, wherefrom most Indian<br />
companies had substituted their green field growth plans<br />
with M & A strategies. This was because of the fact that the<br />
benefit in adopting the takeover route was premised to be<br />
more lucrative as to make this strategy preferable to adopting<br />
the organic growth route.<br />
July-October - 2007 Need the Dough<br />
17
PANORAMA<br />
Competitive impact:<br />
This factor also became an important motive in M&As because<br />
of its impact on competition. Sometimes one of the<br />
motives behind a hostile takeover was to reduce competition<br />
and increase the competitive strength of the acquiring firm.<br />
Thus with the acquisition of TOMCO by HLL, the latter’s<br />
market share increased substantially. In the pharma sector,<br />
Ranbaxy acquired three companies over the period from<br />
1996-1997 to become a market leader by relegating Glaxo<br />
India and Cipla to the second and third spots respectively<br />
by securing and increasing its market share from 3.9 per cent<br />
to 5.3 per cent.<br />
Pre-emptive Motive:<br />
Frequently M&As can also be used as a pre-emptive strategy<br />
if it was felt that a potential competitor was planning to make<br />
a quick and easy entry into a market by adopting the merger<br />
and acquisition route, which may be pre-empted by another<br />
company acquiring that particular firm and depriving the<br />
former from securing the advantage. <strong>The</strong> Indian corporate<br />
sector abounds with examples of such a style as exemplified<br />
by the acquisition of Premier Tyre Company by Apollo<br />
Tyres, etc.<br />
Internal Factors:<br />
In a study conducted in 1991 to establish that efficiency gains<br />
and reduction in expenditure were an important motive for<br />
undertaking M&A, the merger wave of the early 1990s was<br />
analyzed and it was found to be a mere means for undertaking<br />
internal restructuring rather than being an instrument to further<br />
product / market / asset share. Such internal restructuring<br />
also formed an important motive for the spate of mergers<br />
that happened during the 1990s, all of which seemed to have<br />
aimed at increasing size, deriving marketing and financial<br />
benefits and securing economies of scale.<br />
Growth:<br />
<strong>The</strong> Murugappa group in the south was a classic example<br />
of growth achieved by an industrial house by successfully<br />
adopting the M&A strategy. <strong>The</strong> group’s penchant for acquisitions<br />
was that in the past capacities could not be expanded<br />
because of the MRTP constraints and hence the group had<br />
18 Need the Dough July-October - 2007<br />
to take the route of buying up a company through the BIFR<br />
route. However in less than a few years of liberalization, it<br />
had acquired over a dozen companies including EID Parry,<br />
Coromondal Fertilizers, etc.<br />
Portfolio Strategy:<br />
Does M&A contribute to a company’s product portfolio strategy;<br />
that is to say that, does it provide a strategic leverage to<br />
a company for expanding its product portfolio as envisaged<br />
If the acquisition by Hindustan Lever Limited (HLL) of Tata<br />
Oil Mills Co. Ltd. were to be analyzed, it would clearly be<br />
observed that this merger had enabled HLL to consolidate its<br />
market power in the soaps and detergents product segments.<br />
Besides the merger also helped HLL to fill a perceived gap<br />
in this area and improve the geographical distribution of its<br />
production facilities in this segment in India.<br />
Achievement of Economies of Scale and Synergy:<br />
According to various exponents, M&As can improve the<br />
profitability of a company by securing a reduction in overheads,<br />
effective utilization of facilities, improving its ability<br />
to raise funds at a lower cost and deployment of surplus<br />
cash for expanding business with higher returns - a fact that<br />
stands testified by the example of economies of scale and<br />
DERIVATIVES<br />
<strong>The</strong> acquirers<br />
usually targeted<br />
those companies for<br />
takeovers which were<br />
undervalued and<br />
whose replacement<br />
costs were high<br />
synergy achieved by the Brooke Bond and Lipton merger,<br />
both being two Lever Group companies whose businesses<br />
overlapped and merged in the year<br />
1993 to benefit from operational<br />
economies and synergies secured<br />
in this process. <strong>The</strong> HLL, like its<br />
parent Unilever had identified<br />
food business as its major segment<br />
and undertook acquisitions<br />
like its parent Unilever. Brooke<br />
Bond Lipton India (BBLIL) also<br />
adopted a similar strategy by taking<br />
over three key players in the ice-cream market segment,<br />
namely, Kwality, Milk foods, and Dollops, which together<br />
with its own brand i.e. Hostile corporate raids can be classified<br />
as those attempted takeovers which had been undertaken<br />
without the promoters’ consent and by support through the<br />
media market route. <strong>The</strong> acquirers usually targeted those<br />
companies for takeovers which were undervalued and whose<br />
replacement costs were high. In other words, there seemed to<br />
exist a difference between the market value of the assets and<br />
their replacement costs. However, at times it happened that<br />
the market capitalization of many companies were less than<br />
the book values of their assets, in which situation a company<br />
desiring to add to capacity in producing a particular product,<br />
could acquire the additional capacity more cheaply by buying<br />
a company that produced the product rather than produce<br />
the same by building up the infrastructure for such purpose
MERGERS & ACQUISITIONS<br />
from the scratch.<br />
Most of the Indian business houses like, that of the Tatas,<br />
the Birlas, the Thapars, the Singhanias and the Seths had<br />
control in their companies with stakes ranging from fifteen<br />
percent to forty percent. <strong>The</strong>refore, looking at promoter holdings<br />
and current market prices, most of these companies were<br />
still, quite susceptible to hostile takeovers.<br />
Many companies are also playing safe by shoring up their<br />
holdings by buy backs of their shares to thwart hostile corporate<br />
raids for example what HLL did recently. In this<br />
context, companies like, Kesoram Industries, Finolex Cables,<br />
Indian Rayon, etc. had all announced buyback programmes<br />
worth as much as Rs. 400 crores in the year 2003-04. All<br />
these anticipated a loss of corporate control, a fact which<br />
was evident from the case of G.E. Shipping which went for<br />
a second buyback in less than a year as the promoters were<br />
initially holding a meager eighteen percent equity after the<br />
first buyback.<br />
Impact of Mergers and Acquisitions:<br />
Various studies have been carried out for determining the<br />
impact of M&As on the profitability of the merged companies<br />
wherein analysis had been made of the pre merger and post<br />
merger profit margin in respect of a sample of 20 acquiring<br />
firms where there was a decline in profitability in about 10<br />
of these companies after merger.<br />
Overall, acquirers were found to be high growth firms<br />
which had improved their performance over the years prior<br />
to the merger and had higher liquidity. <strong>The</strong> target firms, on<br />
the other hand, were firms that had higher than industry<br />
profitability which had deteriorated over the period just prior<br />
to merger. If pre merger profitability (an index of efficiency<br />
of a company) of acquirer and target companies were to be<br />
compared, the acquiring companies had been found to have<br />
higher pre merger profitability in 20 of the 25 merger cases<br />
studied. This revealed that, in general, the acquiring firms<br />
were found to be more efficient than the corresponding targets<br />
in terms of their profitability.<br />
Integration Aspects in India:<br />
Post merger acquisition or integration of the firms was also<br />
a crucial task that required to be accomplished for securing<br />
effective performance. <strong>The</strong> organizational cultures of the two<br />
companies may have been different and sometimes there may<br />
have been differences in their policies, procedures and styles<br />
as well. Functional facilities and activities would therefore<br />
require be aligning and coordinating for such purpose. <strong>The</strong><br />
most common perception generated by M&As is that there<br />
is a loss of self-determination and post-the M&A phase it is<br />
characterized by a change in strategic stance (and therefore, in<br />
the operating systems) of the acquired company. For instance,<br />
a merger or acquisition to achieve a backward integration<br />
would make it a logical necessity for the target company to<br />
lose its market-orientation and become more of a feeder unit<br />
as would require to plan and produce to suit the priorities of<br />
the acquiring company.<br />
Changed conditions always have the potential for generating<br />
a sense of powerlessness among the employees, and often<br />
kill their initiative and entrepreneurial spirit which becomes a<br />
core issue that needs to be addressed in the acquired company.<br />
Another common offshoot of this phenomenon is the problem<br />
of a sense of alienation among the employees. With people<br />
facing an overhauling of their identity post merger, relationships<br />
which they had built with their organization, its culture<br />
and people - all undergo a cataclysmic metamorphosis.<br />
At the most obvious level, in the post-M&A period there<br />
are changes in the company’s name, marketing strategies,<br />
and control systems. Besides these, employees also have to<br />
contend with many other changes, all of which make their<br />
daily experience of working in the new company strange and<br />
alien. For instance, colleagues of many years either leave or<br />
are transferred to other parts of the organisation, or former<br />
powerful bosses suddenly lose their power and status in the<br />
company all of which affect the emotional quotient of the<br />
employees.<br />
In the HLL-Tomco merger, about 50 top Tomco executives<br />
posted out from the company headquarters left the company,<br />
within a year. Since the executives who left were also the ones<br />
with whom the employees had identified themselves closely,<br />
their departure signified both the psychological as well as an<br />
emotional loss for the existing employees. This dilemma was<br />
well expressed by a senior Tomco manager who has fought<br />
Levers in the market for as much as twenty years, so much<br />
so that he could not mentally accept the situation of working<br />
for the Lever company at this stage of his career, which only<br />
goes to expose one small aspect of the cultural problem that<br />
companies have to contend with when they merge.<br />
However, in the case of HLL the management of HLL<br />
were aware of these issues, and referring to the merger, the<br />
Chairman of the company when asked as to whether the<br />
merger would create cultural mismatches answered that the<br />
culture factor is indeed an issue that they have to take into<br />
consideration for which they have already outlined a strategy<br />
and put it in place. <strong>The</strong> first task of course is to communicate<br />
the plan clearly and if some insecurity creeps in then counseling<br />
would be needed to be undertaken in order to remove<br />
the scope for misunderstanding arising in such a process.<br />
<strong>The</strong> important thing to note is that success or failure of any<br />
new entity would depend largely upon the people affected by<br />
the merger process who are important and who run the new<br />
company. If there is any unhappiness, insecurity or uncertainty,<br />
obviously, the merged company cannot expect to get<br />
the best out of them and this will require a very high degree<br />
of attention.<br />
<br />
July-October - 2007 Need the Dough<br />
19
GLOBAL PERSPECTIVE<br />
A BIG RICH<br />
INDIAN WEDDING:<br />
MERGERS REVISITED<br />
20 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
As much as we wish and<br />
hope the marriage to be<br />
a merger activity, it has<br />
more characteristics of an<br />
acquisition than a merger<br />
<br />
<br />
<br />
Mergers and Acquisitions are rich affairs, just<br />
like our own Indian weddings. However, the<br />
similarity between the Indian weddings and<br />
mergers is not just limited to lavishness and frequently<br />
cited extravagance. Weddings in India can be directly<br />
compared to the corporate mergers in many other aspects<br />
as well. <strong>The</strong> emphasis here is on marriages in India because<br />
in the western world the procedure is not as tedious<br />
as it is in our country. To substantiate further, in both<br />
the above cases, be it an Indian wedding or any other<br />
marriage around the globe (including the cross-country/<br />
cross-cultural/cross-continental mergers) there are a lot<br />
who’s who of the family and relatives (Like the study of<br />
financial statements, Cost-benefit analyses for an M &<br />
A, and the valuation of the target firm) begin. Needless<br />
to mention, the whole cumbersome activity of matching<br />
horoscopes carried out by the Pundits (Consulting<br />
firms) is also an indispensable ritual. Once the marriage<br />
proposal is accepted by the head of the family (Management<br />
acting on behalf of shareholders) and is declared,<br />
a whole lot of activities are undertaken to welcome the<br />
new member into the family (Say, profitability analyses<br />
in terms of sharing of technology, downsizing of labor<br />
and management, etc). Such is the fervor that even the<br />
In order to find the suitable match, parents (Investment<br />
bankers/advisors) use their personal contacts or social<br />
networking means and sometimes even carry out classified ads<br />
of stake holders involved before and after the marriage.<br />
That is, why the process is tedious and why does it take<br />
months of negotiations, speculations and evaluations<br />
before the event actually occurs. Of course, there are<br />
many significant differences between the two. However,<br />
it would not be incorrect to classify an arranged marriage<br />
as a special case of an M&A transaction.<br />
When a marriage takes place in an Indian household,<br />
there is so much of hype surrounding the marriage (and<br />
if it is a celebrity wedding, then media goes gaga just as it<br />
does when it gets a whiff of a potentially large-scale M &<br />
A activity). Months (and at times, even years) before the<br />
‘D’ day, preparations begin. Much before the marriage<br />
is announced, background checking and consulting the<br />
house gets a makeover.<br />
In order to understand this peculiar resemblance further,<br />
let’s take a detailed look at a traditional Indian “arranged<br />
marriage” vis-à-vis a corporate merger:<br />
Parties in question:<br />
As much as we wish and hope the marriage to be a merger<br />
activity, it has more characteristics of an acquisition than<br />
a merger. Blame it all on the social setup that exists in<br />
India. <strong>The</strong> acquirer and the target, here are the bride<br />
and the groom respectively or vice versa. <strong>The</strong> roles that<br />
the two play depends on the social system (in matriarchal<br />
system, bride is the acquirer; while in patriarchal<br />
system, bridegroom is the acquirer). Supposing it to be<br />
July-October - 2007 Need the Dough<br />
21
PANORAMA<br />
a patriarchal system, which is followed by a large chunk<br />
of Indian mass, the bride shifts to the groom’s house<br />
with all her worldly assets and liabilities after the marriage.<br />
<strong>The</strong> price paid by the groom is the cost/expense<br />
borne on the marriage itself (a significant part of which<br />
is shared by the bride’s family, in most cases). <strong>The</strong> cost<br />
incurred by the groom (price paid) has not much of a<br />
bearing on the actual value of the bride (the acquired<br />
firm). “<strong>The</strong> groom’s family can spend pretty much anything<br />
they like; based on their own status (the Fortune<br />
500s of society like to spend a lot on theme marriages,<br />
celebrity dance performances and such other social pastimes).<br />
<strong>The</strong> groom’s side does offer some presents to the<br />
bride and her family, a case which happens to be more<br />
when he or she attains a ‘marriageable age’ or completes<br />
his/her education. In fact, merger transactions between<br />
start-ups (children) are considered to be retrogressive<br />
and illegal. <strong>The</strong> parents (top management) look out for<br />
befitting opportunities in the marriage market to ensure<br />
a harmonized synergy after the marriage. <strong>The</strong> parents’<br />
(top management’s) motivation for their ward’s marriage<br />
might not be on the same plane as their ward’s motivation.<br />
While the top management thinks more practically<br />
and looks for tangible benefits and synergies, the<br />
ward’s motivation might be limited to being romantic<br />
and based on external appearances (Target firm’s size<br />
and turnovers).<br />
“<strong>The</strong> boy’s parents (often, the boy himself, as well)<br />
It is possible to have ‘reverse goodwill’, if the bride brings in a<br />
lot of tangible assets on her parents’ money, over and<br />
above herself<br />
of a cash-and-kind deal.”<br />
Benefits sought:<br />
Have you ever heard of a startup firm or a relatively<br />
young venture being a part of an M & A activity <strong>The</strong><br />
obvious answer is ‘no’. Thus, the fi rms have to reach<br />
maturity stage before they generally seek merger or an<br />
acquisition. This being analogous to the fact that parents<br />
of a boy or a girl start seeking for a suitable “match” only<br />
may not be interested in the girl’s own qualities, but in<br />
her family’s wealth. This is similar to trying to acquiring<br />
a firm for its ‘crown jewels’.”<br />
Acquisition activity:<br />
Now, let us relate the marriage process on whole with the<br />
entire acquisition activity. To begin with, there are two<br />
‘eligible’ parties, the groom and the bride (the acquirer<br />
and the acquiree/target). <strong>The</strong>y both would have shown<br />
their willingness to undertake the acquisition activity.<br />
Now, the parents on either side are like the investment<br />
bankers appointed as advisors. <strong>The</strong>ir objective is to provide<br />
a turnkey solution to their respective wards, with<br />
the wards’ agreement not carrying much significance in<br />
many cases (not unlike the corporate world).<br />
In order to find the suitable match, parents (Investment<br />
bankers/advisors) use their personal contacts or<br />
social networking means and sometimes even carry out<br />
classified ads (publicize on the media). This “alternatives<br />
searching” part of the activity is a long and expansive<br />
function and is done through extensive data-accumulation<br />
of probable matches (of acquirers/acquirees) in the<br />
market. This information, suitably biased by the parents’<br />
advisors according to their own liking, is presented to<br />
the ward. Third-party agents like classified ads, matchmakers<br />
and match-making websites are a good means of<br />
alternative search for those parents who haven’t spent<br />
much time on the networking front and need some consultation<br />
support in the search process.<br />
<strong>The</strong> probable matches are then rigorously studied and<br />
screened by the client-ward on behest of the advisor-par-<br />
22 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
ent. <strong>The</strong>re might be differences in the benefits sought by<br />
the client-ward (which generally is short-term benefits)<br />
and those suggested by the advisors and the ward might<br />
feel it is not being given the service quality that it deserves.<br />
<strong>The</strong> ward and the parents may not agree on what<br />
‘synergies’ to focus on.<br />
“When the candidates on the two sides agree to explore<br />
matters a bit further with a shortlist of counterparties,<br />
the process of due diligence begins with due<br />
earnestness. “<br />
Now, some more evaluation of the acquirer and target<br />
are done to ensure there is no friction amongst the parties<br />
after the merger. <strong>The</strong> information being sought are;<br />
the boy’s salary, people in the boy’s house, the character<br />
of the girl (hardly anybody bothers about the boy’s<br />
character), the quality of management in the boy’s house<br />
(his parents), and whether the boy lives in a joint family<br />
(which may be categorized under ‘environmental issues’).<br />
In the final stages, just before the marriage, situation<br />
gets grimmer and a series of negotiations unfold with<br />
the advisors on both sides playing hardball as they try<br />
to promote their own benefits and struggle to make the<br />
transaction as propitious for themselves as possible. This<br />
is just like the final negotiations in an M & A transaction.<br />
<strong>The</strong> difference is that all these vehement discussions are<br />
verbal, and unlike an M & A these deliberations are not<br />
taken down frantically by a big team of lawyers.<br />
“When a deal has been successfully thrashed out, the<br />
two sides issue a joint statement publicizing the engagement,<br />
often giving indicative timelines for the completion<br />
of the deal (marriage).”<br />
Just like in a corporate merger, timing of the announcement<br />
is important for other candidates in the<br />
market who might also have set their sights on one of<br />
the two sides just engaged.<br />
Dramatization of events:<br />
Large corporate houses seeking M and A activity create<br />
a high drama environment in the corporate world,<br />
especially when there are deviations from the above mentioned<br />
stream of events. Such high-voltage drama is not<br />
uncommon amongst the Indian arranged marriages too.<br />
If one party is less desperate or needy for the match than<br />
the other, the party might pressurize the other by starting<br />
dialogue with other parties in market, so as to get an<br />
improved offer from the latter. “At times, the acquiree<br />
(girl) may not like her parent-advisors’ choice of suitor<br />
and look out for a ‘white knight’ more acceptable to her.<br />
Or, sometimes, even other candidates, jealous of a particular<br />
match-up, may spread canards about the candidates<br />
or their top managements to sow the seeds of doubt on<br />
either side.”<br />
Post-merger challenges:<br />
As in the marriages, the actual confrontation of interests and<br />
the murkier hidden-truth comes out only in the post-merger<br />
integration phase. Mergers are not always seen to solve<br />
problems but they also have the ability to create a new set<br />
of problems and opportunities. Mergers need to be treated<br />
as other long-term relationships with an emphasis on the<br />
communication patterns that evolve in healthy or destructive<br />
manners. <strong>The</strong> paradox in a marriage and a merger is that<br />
seemingly insignificant patterns in conversations between<br />
individuals are crucial in the longevity and health of the<br />
relationship. Both sides may discover hidden liabilities in<br />
the counterparty, renege on the verbal conditions agreed<br />
to during the negotiation, experiencing of managerial ego<br />
clashes, strive to take a profitable position in the ‘market<br />
for marital control’, etc. “In the worst case, the husband’s<br />
family carries out ‘asset stripping’ - the practice of using up<br />
or selling the wife’s belongings and not letting her carry on<br />
operations (her job) or even murdering her for dowry.”<br />
Accountability:<br />
“In the corporate world, accounting for M and A can be<br />
done using one of two methods: the purchase method or the<br />
pooling of interests method. Now, most married people will<br />
agree that, on a philosophical level, if not at a financial one,<br />
there is no real ‘pooling’ of interests post-marriage. Thus,<br />
the purchase method of accounting wins by default.”<br />
This in turn, might not be an ideal way of accounting and<br />
has its own flaws when the purchase method for marriage<br />
is actually applied. In general, the additional expenses that<br />
the acquirer incurs (in terms of lucrative incentive-filled<br />
payments) or the premium it pays over and above the actual<br />
value of the identifiable tangible & intangible assets of the<br />
acquiree is classified as goodwill on the acquirer’s balance<br />
sheet. So there is no goodwill. Rather, it is possible to have<br />
‘reverse goodwill’, if the bride brings in a lot of tangible<br />
assets from her parents’ money, over and above herself. <br />
References:<br />
●<br />
●<br />
●<br />
‘M & A: <strong>The</strong> Odd Couple – By George Skaria,<br />
Business Today (http://www.<strong>india</strong>-today.com/btoday/07111998/ma.html)<br />
Arranged marriages as social M&A activity – November<br />
18th, 2006 - Posted by tavaishnav (http://<br />
tavaishnav.wordpress.com/2006/11/18/arrangedmarriages-as-social-ma-activity/)<br />
Merger as Marriage: Communication Issues in<br />
Post-Merger Integration - Kevin J. Dooley, Arizona<br />
State University, Brenda J. Zimmerman, McGill<br />
University<br />
July-October - 2007 Need the Dough<br />
23
TRENDS<br />
Jet Airways –<br />
Air Sahara<br />
merger<br />
“Lite” at<br />
the end of<br />
the Tunnel<br />
<br />
<br />
<br />
<br />
24 Need the Dough July-October 2007
MERGERS & ACQUISITIONS<br />
<strong>The</strong> Mumbai-based Jet Airways board met in<br />
December 2005 and approved the acquisition<br />
of the 100% Delhi-based Air Sahara, which<br />
is wholly owned by the Sahara Group. Specific terms<br />
were not disclosed, but the airline said that it would<br />
be an all-cash deal worth around $500 million and it<br />
didn’t include the assumption of Air Sahara’s debts.<br />
<strong>The</strong> takeover - the biggest in India’s aviation history<br />
– would create the country’s largest airline. Jet Airways,<br />
which was founded by a London-based former travel<br />
agent Naresh Goyal, controls about 35% of the Indian<br />
domestic airline market. According to analysts the deal<br />
would help the company consolidate its position in<br />
India’s flourishing aviation market.<br />
Air Sahara, owned by the reclusive businessman<br />
Subrata Roy, controls about 12% of India’s market.<br />
Air Sahara and Jet Airways are India’s largest privately<br />
owned carriers with a combined domestic market share<br />
close to 50%. Jet Airways is even larger than the stateowned<br />
Indian Airlines, which is its closest competitor<br />
with around 25% market share. Both Jet Airways and<br />
Air Sahara have extensive domestic networks and limited<br />
international operations, and they were the only<br />
survivors from the Indian government’s fi rst attempt<br />
at liberalisation in the early 1990s, when more than a<br />
dozen new carriers launched services.<br />
Mr. Goyal said there were no plans to convert Air Sahara<br />
into a low cost carrier. Air Sahara would continue<br />
to operate separately in the near term, but eventually<br />
Jet Airways would absorb the smaller airline’s aircraft,<br />
airport facilities and technical operations, after which<br />
the Air Sahara name will disappear. A joint integration<br />
team was thus formed under the vigilance of senior<br />
executives from both the airlines.<br />
Delhi-based Air Sahara has been in the market for<br />
some time as it needed cash to expand and its promoters<br />
were not willing to make the necessary investments,<br />
while Jet Airways is fi nancially comfortable following<br />
a successful public offering. Kingfisher was considered<br />
a front-runner in the bidding for Air Sahara, but its<br />
flamboyant Chairman, Vijay Mallya, said while withdrawing<br />
his offer shortly before the Jet Airways deal<br />
was confi rmed, that the asking price was far too high.<br />
Many industry observers see the Jet Airways move as<br />
one intended primarily to keep Kingfisher and other<br />
new players from becoming stronger competitors.<br />
<strong>The</strong> fleets of Air Sahara and Jet Airways are not<br />
radically different, as both operate Classic and Next<br />
Generation Boeing 737 narrow bodies on the majority<br />
of their routes. Jet Airways has more than 50 aircraft,<br />
some 40 of which are 737s, which it acquired through a<br />
mix of lease and purchase. It also possesses eight ATR<br />
72s and three Airbus A340-300s, in addition to fi rm<br />
orders with Airbus and Boeing for 10 A330-200s, 10<br />
777-300ERs and 10 more 737-800s. Delhi-based Air<br />
Sahara operates nearly 30 leased aircraft, around 20 of<br />
which are 737s. It also has seven Bombardier CRJ200<br />
regional jets and a recently added 767-300ER which it<br />
leased for the new London - Heathrow services.<br />
<strong>The</strong> deal could also mean more international routes<br />
for airlines, as Jet Airways and Air Sahara were the only<br />
two private Indian carriers who were permitted to fly<br />
overseas. Jet runs 271 scheduled fl ights daily within<br />
India. It recently won the government’s permission<br />
to fly to London, Singapore and Kuala Lumpur. Air<br />
Sahara operates 134 fl ights daily in India. It has recently<br />
begun flying to US, London and Singapore as well.<br />
According to aviation analyst Alok Dayal, the takeover<br />
would not affect the passenger fares much in an<br />
<strong>The</strong> fleets of Air Sahara and Jet Airways<br />
are not radically different, as both operate<br />
Classic and Next Generation Boeing 737...<br />
industry which has seen explosive growth due to the<br />
entrance of low cost carriers. “Both Jet and Air Sahara<br />
are full-cost airlines and do not offer low fares<br />
as compared to low cost carriers. So I think the low<br />
cost carriers will continue to give competition to these<br />
airlines”, he said.<br />
Hiccups:<br />
That the proposed merger between Jet Airways and<br />
Air Sahara would not go ahead, is news which came as<br />
a heavy blow to the Indian aviation industry.<br />
Airline officials have said that the merger worth<br />
USD500m has fallen through due to a combination<br />
of procedural delays and disagreements between the<br />
two airlines. <strong>The</strong> deadline for the merger was 21st June<br />
2006. With the approach of the deadline for regulatory<br />
approval, Air Sahara was willing to extend the deadline<br />
by 15 days, but Jet Airways did not agree to an extension<br />
unless the purchase price was reduced by 10-20%.<br />
Later, Air Sahara rejected this proposal.<br />
Questions from the Indian government regarding<br />
airport-landing slots, is another reason which had<br />
jeopardized this planned merger between Jet Airways<br />
and Air Sahara. According to the media, India’s civil<br />
aviation authorities are questioning all of Air Sahara’s<br />
landing slots being transferred to Jet Airways. <strong>The</strong> authorities<br />
reportedly fear that the merged airline could<br />
have too much control over airport parking bays. A<br />
July-October 2007 Need the Dough<br />
25
TRENDS<br />
report stated that the government takes the view that<br />
airport facilities have been leased to Air Sahara and<br />
would not automatically transfer to Jet Airways, the<br />
report said. Jet Airways has apparently included the<br />
slots in its valuation of Air Sahara.<br />
<strong>The</strong> merger was approved by the Ministry<br />
of Company Affairs but not by the Civil<br />
Aviation Regulation Board as reported by<br />
media that time. <strong>The</strong> technical cause for<br />
missing the deadline was a government delay<br />
in approving the appointment of Jet Airways<br />
chairman Naresh Goyal to the board of Air<br />
Sahara after the acquisition.<br />
If completed, the merger would have created<br />
the largest Indian airline with control over nearly<br />
half the market. Jet Airways and Air Sahara continued<br />
to battle at the press, over possession of<br />
<strong>The</strong> Company plans to increase its revenue<br />
from international operations to 50% of<br />
the total earnings within the next 3 years<br />
an INR 5billion ($108.5 million) escrow account tied<br />
to Jet’s aborted acquisition of its much smaller rival.<br />
<strong>The</strong> merger, which was announced in January 2006,<br />
fell apart after Jet seemingly walked away rather than<br />
extending the deadline to June 21 in order to complete<br />
the deal. While Jet offered little explanation for the<br />
decision, Air Sahara claimed that Jet dropped the deal<br />
after Sahara rejected a request to lower the $500 million<br />
purchase price by 10%-20%.<br />
Final Move:<br />
Nine months after lapsing its proposal to take over<br />
Air Sahara, Jet Airways had revived its bid. After the<br />
deal failed to get regulatory approvals, Jet said the<br />
earlier it had decided not to pursue the acquisition for<br />
commercial reasons and in the interest of its shareholders.<br />
Sahara had argued that the deal should have been<br />
completed, and asked for compensation.<br />
A three-member arbitration panel was set up to resolve<br />
the dispute between the two airlines over the<br />
disputed merger. <strong>The</strong> two airlines, after two days of<br />
closed-door talks in Mumbai, submitted the re-worded<br />
sale purchase agreement to the three-member arbitrators’<br />
panel. <strong>The</strong> delay in hammering out the consent<br />
order was on account of some differences between the<br />
two sides on payment procedures.<br />
Air Sahara had fi nally landed on Jet Airways runway,<br />
ending nearly 10 months of dispute between the<br />
two airlines. Naresh Goyal, Chairman, Jet Airways<br />
announced that it had agreed to buy out Air Sahara<br />
in an all-cash deal for Rs 1,450 crore, which is about<br />
40 per cent less than the Rs 2,300 crore that Jet had<br />
agreed to pay for the acquisition in<br />
January 2006.<br />
Mode of payment:<br />
While Rs 500 crore had already<br />
been paid to Sahara after the fi rst<br />
agreement was inked between the<br />
two in January 2006, next installment<br />
of Rs. 400 crore paid on or<br />
before April 20, 2007. <strong>The</strong> remaining<br />
Rs 550 crore will be paid in<br />
four equal annual and interest-free<br />
installments during the next four<br />
years ending 2010-11 commencing<br />
on or before March 30, 2008.<br />
Mr Goyal said at the current interest<br />
rate, the Net Present Value of the<br />
lump sum price was in the vicinity<br />
of Rs 1,200 crore. He, however, did<br />
not touch upon the liabilities of Air<br />
Sahara including about Rs 200 crore<br />
credit outstanding. Sources said Jet<br />
would have to bear these liabilities,<br />
which would enhance its acquisition cost.<br />
<strong>The</strong> buyout will make the merged entity the largest<br />
domestic private carrier, with a market share of about<br />
42 per cent and a fleet of 88 aircrafts, including the<br />
27 operated by Air Sahara. Incidentally, all the Sahara<br />
aircrafts are on lease. <strong>The</strong> buyout will also help Jet in<br />
its plans to go international.<br />
<strong>The</strong> company plans to increase its revenue from<br />
international operations to 50 per cent of the total<br />
earnings within the next three years. <strong>The</strong> company has<br />
applied for rights to expand its international network to<br />
connect India to key destinations across the world, including<br />
the US, Canada, the UK, South Africa, Kenya,<br />
China and South East Asia.<br />
Impact:<br />
Briefi ng newspersons in New Delhi, the Air Sahara<br />
President, Mr Alok Sharma, said that the deal had been<br />
closed on an as-is-where-is basis. “<strong>The</strong> deal will see Jet<br />
Airways get Air Sahara in its current position. All the<br />
Government approvals for the deal are in. <strong>The</strong> deal is<br />
beneficial to all parties. Not only will Jet Airways get<br />
to operate on our routes, it will also get the existing<br />
fleet and the 10 brand new Boeing 737 aircraft being<br />
delivered to us. Besides, Jet will also get a larger market<br />
26 Need the Dough July-October 2007
MERGERS & ACQUISITIONS<br />
share and more loyal customers”, Mr. Sharma said. <strong>The</strong><br />
deal allows the Air Sahara brand to continue for some<br />
more time after which it would revert to the owners<br />
of Sahara group. Assets of Air Sahara including four<br />
helicopters and the personal Boeing Business Jet of<br />
the Sahara Group Chairman would be carved out and<br />
sold back to Sahara.<br />
<strong>The</strong> completion of the deal will not affect the existing<br />
3,700 Air Sahara staff. “If required, Sahara will<br />
absorb all employees at the same terms and conditions”,<br />
Mr Sharma added. While Jet Airways is likely to absorb<br />
the pilots, cabin crew and engineers with Air Sahara,<br />
the rest of the staff are likely to be absorbed by the Sahara<br />
group, sources indicated. On the other hand when<br />
asked whether Jet will rename Sahara, and whether<br />
the airline would retrench any Air Sahara employees,<br />
Mr Goyal said he would answer all the questions later.<br />
Reacting to the development, the Jet Airways stock<br />
increased by 3.24 per cent to close at Rs 628.65 on the<br />
BSE on April 12, 2007.<br />
Post Merger Scenario:<br />
Jet Airways, which recently took over the beleaguered<br />
Air Sahara for Rs 1,450 crore, has rebranded the lowcost<br />
carrier `JetLite’. According to Jet, the combined<br />
entity would have a market share of 33 per cent of the<br />
domestic market and a combined FY08 net revenue of<br />
$2.5 billion. However, Jet and Air Sahara will operate<br />
as independent companies and Jet Airways would raise<br />
$400 million to fund overseas expansion.<br />
Jet Airways is also planning to acquire 20 widebodied<br />
aircraft for $2.1 billion. It would comprise 10<br />
state-of-the-art Boeing 777-300 (extended range) and<br />
ten A330-200 Airbus aircrafts.<br />
While the airline has redesigned everything, offering<br />
new products in the fi rst, premier and economy<br />
classes, the airlines also holds options of adding more<br />
aircrafts of each type and have recently signed a deal<br />
for purchase of 10 Boeing 787 Dreamliner with delivery<br />
commencing in 2011, which will cost the company<br />
$1.6 billion. In all, Jet Airways will invest $3.7 billion<br />
in new aircrafts for its aggressive growth strategy for<br />
both domestic and international market. All facilities<br />
offered will be premium and hence a premium will<br />
have to be paid by the passengers but the prices will<br />
be competitive, a senior Jet Airways official said. <br />
1 3 d e c 2 0 0 7<br />
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e c o n o my i n d i a ’ s m o s t i n f l u e n t i a l b u s i ne s s a n d maga z i n e<br />
India’s No. 1<br />
Business & Economy<br />
Magazine<br />
m a g a z i n e<br />
ALSO IN THIS ISSUE<br />
SIZZLING<br />
NEW GRASSROOT TECHNOLOGIES<br />
GIZMOS ’08<br />
LIFE IN SECOND LIFE<br />
WHAT WILL HAPPEN IN THIRD & FOURTH LIFE<br />
COLUMNS BY RAY KURZWEIL & JEFF KAGAN
TRENDS<br />
THE SURGING TSUNAMI -<br />
MERGERS & ACQUISITIONS<br />
STORY…<br />
28 Need the Dough July-October 2007
MERGERS & ACQUISITIONS<br />
<strong>The</strong> restructuring exercise is carried out to gain<br />
optimum utilization of resources and re-focus on the<br />
objectives and changed business dynamics<br />
<br />
<br />
Breaking News:<br />
● Havells India acquires SLI Sylvania, Germany – deal<br />
size US $ 300 mn<br />
● Suprajit Engg buys out CTP Gills Cable of UK – deal<br />
cost US $ 5 mn<br />
● Batliboi Ltd acquires Quickmill Inc in Canada – worth<br />
INR 22 crores and buys AESA of France – deal size<br />
INR 9 crores<br />
● Tata Steel outbid their South American rival for Corus<br />
– deal size US $ 12.1 bn<br />
● Karuturi Networks acquires Sher Agencies , a Dutch<br />
outfit – cost US $ 69 mn<br />
● Suzlon successfully bids to buyout REpower in the<br />
wind energy segment – deal size $ 1.35 bn<br />
● Wipro acquires the healthcare providers of S.E. Asia<br />
to gain geographies and enhance their health and<br />
personal care product range.<br />
● Wipro Technologies acquires Infocrossing of US in<br />
a all cash deal of US $ 600 mn<br />
● JSW Steels India buys Steel Saw Pipes, USA, Jindal<br />
United Steel Corp., US & Jindal Enterprises LLC<br />
USA totaling a whopping US $ 940 mn / INR 3845<br />
crores<br />
A typical though small sampler of headlines making<br />
it to the daily newspapers in the first half of the year<br />
2007 ---<br />
Headlines such as these have become an everyday<br />
feature and inevitable too. To comprehend the reasons<br />
pertaining to such frequency in the world of mergers<br />
and acquisition , if we peel off the layer of hectic activity<br />
and biddings, dealings <strong>going</strong> on, the causes and the<br />
underlying matter attracting such deals and sustaining<br />
this rapidly ballooning phenomenon can be seen to be<br />
fundamentals emerging from the economic structure.<br />
<strong>The</strong> present multi-hued conglomerations, mega deals<br />
are all seen to be happening on the strength and structure<br />
of the developing thriving economy and in turn is<br />
also facilitated by the liberalization policies and growing<br />
economy. Quite a case of success breeding success, if<br />
one could say so.<br />
Growth <strong>The</strong>me:<br />
<strong>The</strong> dominant theme for India Inc`s M & A outreaches<br />
is simply this: Growth. Catch up with the biggies out<br />
there as quickly as possible.<br />
● Growth – Evolve, Empower<br />
Being in a phase of economic transition, introspecting,<br />
exploring the unfolding opportunities, investing for a<br />
bigger and better profitable tomorrow helps in evolution<br />
and empowerment of the business<br />
● Growth – Uniqueness, Innovation<br />
<strong>The</strong> present day business dynamics ensure growth only<br />
and if only there is enough preparedness, innovation,<br />
thinking processes devoted to creating uniqueness of<br />
products and services<br />
● Growth – Value addition, Differentiation<br />
<strong>The</strong> businesses of today have to compete in open environs<br />
to be able to gain and retain interest and attract<br />
brand loyalty and trust in preference to other products in<br />
the range which can only be secured with differentiation<br />
and value addition.<br />
● Growth – Vision, Mission<br />
<strong>The</strong> growth on the basis of planned out investments<br />
leads to a higher plane of vision, the scale of operations<br />
perceptibly richer and varied with the mission also rolling<br />
on to newer domains, intact and fully compatible with<br />
commercial interests.<br />
This Growth to happen in a defined period of time<br />
and space, to realize all these dramatically resultant significant<br />
energies need the added impetus given by M & A<br />
activities, (inevitably incremental fund flows too!) as the<br />
internal accrual method of gaining strength is definitely<br />
a slower, slightly restrictive process though very much in<br />
the realm of possibilities. Just as a specialist sportsperson<br />
needs general fitness and agility before training in the<br />
special features of the game, so do the economy, industry<br />
and firm need to be basically fit before attempting to gain<br />
speed and competitiveness in a specialist zone.<br />
A cursory glance at the basic sectoral array of the firms<br />
confirm the view that the proactive expansion growth<br />
plans are happening across the board – from engineering,<br />
Information Technology, by Mr. ITES Jangoo to healthcare, Dalal power<br />
and infrastructure to even Sr. VP-Enterprise, horticulture firms Cisco Systems – with no (India & SAARC)<br />
sector lagging behind.<br />
Deal sizes range from a hefty US $ 1 billion and more,<br />
as in the case of Tatas to as tiny as US $ 2/3 millions<br />
and gauging which the size gradation ranges from neo<br />
corporates, niche players in their selected segments to<br />
July-October 2007 Need the Dough<br />
29
TRENDS<br />
established giants of the industries like Tatas.<br />
Of course not all of the deals are outbound and cross<br />
border acquisitions, but there are also domestic buyouts<br />
and consolidation, a good example of it is seen in the<br />
banking space wherein small private sector banks like<br />
Nedungadi Bank and Lord Krishna Bank have been<br />
merged with more powerful Banks in order to remain<br />
competitive and to confirm adherence, compliance to<br />
the regulators` benchmark rates.<br />
<strong>The</strong> Hidden Picture:<br />
Lost in this story abounding in outbound, cross border<br />
deals is that firms are also hiving off, de-merging in an<br />
attempt to focus better or effect change in control by<br />
offering certain units to other foreign firms and willingly<br />
merging within themselves to form a well, slimmer, fitter<br />
and powerful units. Biocon divesting its Industrial<br />
Enzyme unit to a Norwegian firm – Novozymesa is a<br />
case of strategic fit wherein it can be more focused on<br />
its Bio-pharmaceuticals space, maintaining faster growth<br />
momentum while leaving behind food industry application<br />
areas. Similarly IBR Infrastructure Developers-<br />
IBRID merged all subsidiaries and SPVs with themselves<br />
to form a single holding Co. <strong>The</strong> objectives achieved are<br />
integrated approach, greater control of activities in the<br />
construction projects apart from <strong>global</strong>ly valid true core<br />
transparency and ethical practice of accounting in the<br />
books. <strong>The</strong> restructuring exercise is carried out to gain<br />
optimum utilization of resources and re-focus on the<br />
objectives and changed business dynamics.<br />
Why the deal<br />
To have instant growth, to gather and retain growth<br />
momentum, to gain competence and jump on to the outsourcing<br />
bandwagon and explore/exploit better revenue<br />
yielding opportunities. Here the vital point to be noted<br />
is the time frame with which one has to be sync.<br />
Augmenting export earnings, partially de-risking geopolitical<br />
competition, gaining access to newer markets<br />
thus overriding cyclical downtrends in established exposure<br />
domains is a strategic move in M & A situations. To<br />
take on domestic competition, to retain competitive edge<br />
with economies of scale, wider product range and simultaneously<br />
to maintain <strong>global</strong> level quality and standards<br />
in business practices, the bottom line in all these activities<br />
is to be able to realize economies of scale, enhance<br />
product range and market share, to improve margins<br />
and add to instant growth while complying with <strong>global</strong><br />
standards, all form compelling forces.<br />
Ways & Means:<br />
Consolidation of businesses by large industrial houses,<br />
multinationals operating in India, increasing competition<br />
amongst domestic companies and against imports<br />
has all combined to spur mergers and acquisitions activities<br />
in India. In response to the growing business,<br />
<br />
<strong>The</strong> bottom line in all these<br />
activities is to be able to realize<br />
economies of scale, enhance<br />
product range and market share...<br />
<br />
regulators have issued guidelines to facilitate smooth<br />
transactions.<br />
Mergers and acquisitions take the form of<br />
● Modes of cross border acquisitions<br />
● Categories of cross border acquisitions<br />
● Open offers<br />
- Acquisition of shares<br />
- Acquisition of undertaking/assets<br />
● Substantial sale of equity<br />
● Corporate partnering<br />
Strategic investments<br />
● Earn out acquisitions<br />
● Public to private– Leveraged buy outs<br />
● Sale of distressed assets by financial intermediaries<br />
30 Need the Dough July-October 2007
MERGERS & ACQUISITIONS<br />
– Distress sale<br />
● Schemes of arrangement by companies, etc. – Supporting<br />
management buy outs<br />
<strong>The</strong>re is also a rising trend in buyback of issued equity<br />
by companies. Disinvestment is also an acquisition by<br />
the new owners of the business hitherto owned by the<br />
government. This trend is as significant at the State level<br />
(if not more) as compared to the Central government.<br />
Private Equity or PE players are actively promoting<br />
all forms in this trend. Along with dedicated foreign<br />
funds with Asia / India / Emerging Markets specific<br />
nature, funds scout around for profitable and promising<br />
ventures and organizations wherein they can participate<br />
and fund the action deals.<br />
Composition and Constituents:<br />
M & A activity which started as stray instances in the<br />
80s started to trickle in the 90s and becoming a surging<br />
phenomenon in this decade, thereby taking tsunami<br />
– like proportions in 2007. <strong>The</strong> figures tell the entire<br />
story: considered in no. of deals, in terms of deal size,<br />
in the sector of economy covered, competition faced,<br />
et all. <strong>The</strong> absolute numbers were to the tune of <strong>global</strong>ly<br />
transacted 24806 deals amounting to US$ 2059 bn<br />
worldwide while India’s share in that was roughly to the<br />
tune of 394 transactions amounting to around US $ 10<br />
bn in the year 2005 which saw a steep rise of 52% over<br />
the previous year and thereby promising to outbeat the<br />
previous year by a good measure in 2006.<br />
While the activity was seen mainly in the domestic<br />
markets, with firms acquiring a certain critical mass,<br />
the focus then shifted overseas. <strong>The</strong>n again in 2005<br />
the majority of action was seen in the IT and ITES<br />
sectors, the following year saw transactions in general<br />
engineering industry and infrastructure segments. <strong>The</strong><br />
average size of the deal also rose significantly – US $<br />
794 mn for the top 20 transactions – much higher than<br />
the previous years` average of US $ 538 mn.<br />
<strong>The</strong> chart showing the value of deals done by India<br />
Inc., referenced in terms of US $ million against FY<br />
2001 to FY 2006<br />
<strong>The</strong> stats give a very healthy picture of M & A activity<br />
area. <strong>The</strong> different categories of this phenomena, namely,<br />
domestic, international, whether in-bound or outbound,<br />
or be it integration upward / backward or attracting<br />
diverse interests and work areas, to expand geographies,<br />
to increase numbers, gain strength and competitiveness,<br />
to strategise – whatever may be the compelling driving<br />
force, this form of inorganic growth has been resorted to.<br />
<strong>The</strong> only damper to this great show of numbers is that<br />
when viewed in the <strong>global</strong> context, that is as a percentage<br />
of the amount of funds flowing into other emerging<br />
economies, like our great neighbor the awakening dragon<br />
China or Mexico - the other nation joining the band of<br />
fast developing nations, India’s share is quite small and<br />
apparently remains lagging behind.<br />
Support Structures:<br />
<strong>The</strong> steady growth in all sectors of the Indian economy,<br />
the policies and regulators placing a level field of operations<br />
enabling good competition and freeing the processes<br />
of handicaps have gone a long way in fulfilling this<br />
dream run for India Inc’s member units.<br />
<strong>The</strong> political will of the country along with its governance<br />
institutions have enabled the economic growth<br />
activities of the country, maintaining low inflation volatility<br />
and on the other hand containing the risk to price<br />
stability. <strong>The</strong> authorities’ guidance has been effective<br />
in chanelising the corporates into productive economic<br />
ventures. <strong>The</strong>re has been a surge in the interests of gaining<br />
practical work experience and of good management<br />
skills and efficient financial organizing which have paid<br />
rich dividends in terms of contribution to growth<br />
<strong>The</strong> gross domestic product has been growing at an<br />
appreciable 6% and more in the last few years, last year<br />
registering a 9 % and 2007 estimated to clock the same<br />
rate atleast. With inputs from technology, better farming<br />
practices and good overall monsoon, the agriculture<br />
sector also has been supporting the economic growth<br />
story.<br />
<strong>The</strong> IT sector progressed as an island of growth in the<br />
early years of 2000 which had a cascading effect on other<br />
sectors and rub off on engineering goods industry, infrastructure<br />
sectors, telecom, power and services all picking<br />
up strength and growing to boost economic growth.<br />
Growing domestic consumption induced demand increasing<br />
in the economy, industrial performances have<br />
matched the demand and created a local plough back of<br />
capital in building utilities and assets.<br />
<strong>The</strong> capital formation, investment by firms in plant<br />
and machinery, capital goods and capex programs and<br />
abundant capital flows thru FDI and FII has been substantial<br />
facilitating growth and M & A transaction deals.<br />
July-October 2007 Need the Dough<br />
31
TRENDS<br />
<strong>The</strong> FII funds inflow for the 1st half year of 2007 has<br />
been in the region of US $ 85 bn which is a significant<br />
indicator of the trend. Thus real industrialization and<br />
economic progress has been happening and encouraging,<br />
facilitating M & A deals. A T Kearney have graded<br />
India a high 2nd in their FDI Confidence Index indicating<br />
the safety of funds invested in India and ability of<br />
the firms to meet their debt obligations in time. Other<br />
support systems are the rich FX reserves accumulated,<br />
buoyant capital markets, stable equity markets with rich<br />
fund flows, lower cost advantage in industrial manufacture<br />
esp. in steel, cars and pharma, Etc.<br />
Progressive, Pro-growth financial sector regulators and<br />
frontier growth in the financial services delivery modes<br />
have been great supporters of transactions in this area.<br />
While LIC the only insurance player in the Indian<br />
context had always participated, the entry of many other<br />
private insurance players have added additional funds,<br />
<br />
M & A deals are done to derive a<br />
greater benefit from the merged<br />
entity rather than from the<br />
individual bits<br />
<br />
direction and depth to the capital markets’ productive<br />
funds flow pattern.<br />
<strong>The</strong> maturation in the financial sector, freer flow of<br />
funds, better ability for integration of accounts, elevated<br />
corporate governance concepts, and the opening of most<br />
sectors to foreign competition enabled in good measure<br />
in creating the atmosphere needed for the sudden spurt<br />
seen in this growth pattern.<br />
Ready availability of a big talent pool of Management<br />
professionals which is well trained and experienced in<br />
present day trends and <strong>global</strong> cues facilitate the mergers<br />
in all phases of the process.<br />
Enablers:<br />
<strong>The</strong> emergence of the business economic intelligence<br />
and corporate competitive intelligence on the macro<br />
structure has played a pivotal role in enabling environment<br />
for M & A deals. <strong>The</strong> valuations of target firms<br />
are estimated and then negotiations conducted to find<br />
a perfect ‘fit’ in terms of costs. Financial Institutions<br />
/ Agencies / Finance professionals / Business Bureaus<br />
doing the valuations step up to do the number crunching<br />
exercises.<br />
Advisors are the next tier of professionals to step in<br />
who undertake due diligence studies, cover the legal and<br />
tax-oriented aspects of the deal and are designated as<br />
overall in charge of negotiations in seeing the deal thru.<br />
<strong>The</strong> advisor is generally from the financial background<br />
efficient at putting together a package of finances agreeable<br />
to both parties, look into legality aspects of operative<br />
clauses with reference to both countries legislation<br />
and taxation aspects (implying a <strong>global</strong> perspective and<br />
knowledge) applicable to all concerned. <strong>The</strong> impact on<br />
books of accounts pre as well as post merger are considered<br />
for the acquirer and target firms. This ensures<br />
the viability of the deal post merger, assuring that the<br />
resultant energies and benefits are greater than the sum<br />
of its parts and that the deal is truly a benefit.<br />
<strong>The</strong>re are Integrated Service Providers – doing the<br />
numbers, arranging finances, negotiating, conducting<br />
due diligence, etc., creating a customized, end-to-end<br />
solution. <strong>The</strong> Management Services personnel, experts,<br />
specialists educated in the burgeoning B-schools in India<br />
and abroad help in providing Advisory-cum-Boutique<br />
Services in this direction.<br />
Expected Issues / Fallouts:<br />
M & A deals are done to derive a greater benefit from the<br />
merged entity rather than from the individual bits. So it<br />
should be undertaken only when this criteria is fulfilled<br />
or sound the alert and drop the plan, timing and environments<br />
being very crucial to the deal. No deal needs<br />
to be gone thru just because it has been initiated.<br />
Integration – management setups, human resources,<br />
cultural practices, work ethos of the organisations need<br />
to be blended, top-down to gain acceptance at all levels.<br />
<strong>The</strong> objectives of the merger operation need to be clearly<br />
delineated to gain empathy to remove misconceptions<br />
and to promote commitment and vigor to the program.<br />
Job trims, redundancies, remuneration patterns post<br />
merger are sensitive issues to be discussed in detail and<br />
to be applied impartially. This is the difficult part in<br />
absorption post merger.<br />
Bringing out a unified set of Books of Accounts is<br />
another exercise which has to be done, in line with the<br />
statutes and provisions which although is challenging<br />
and requires skill and knowledge, can be got done with a<br />
clinical efficiency, an easier task than fusing the cultural<br />
and human aspects of the two or more entities involved<br />
in the merger plan.<br />
Corporate governance and adherence to principles of<br />
transparency, unbiased and impartial conduct with the<br />
management cadres and being candid and fair in dealings<br />
is essential in bonding in the new environs and creating<br />
enthusiasm and drive among staff members to get<br />
the brand new organization <strong>going</strong> full speed ahead.<br />
Way to go India Inc., it’s very cool, yah! <br />
32 Need the Dough July-October 2007
TRENDS<br />
M & As Calling:<br />
Indian Inc. on a Buying Binge<br />
34 Need the Dough July-October - 2007<br />
No decision is good or bad<br />
in the world of business; it’s<br />
the outcome which makes it<br />
good or bad...
MERGERS & ACQUISITIONS<br />
<strong>The</strong> golden bird of the world is gaining its glitter<br />
once again and recent times bear a true testimony<br />
for her accomplishments. India’s economy crossing<br />
the $1 trillion GDP benchmark, rupee value getting<br />
stronger against the USD, mounting inflation taking a<br />
back seat, Sensex making through the 15k mark and innumerable<br />
other instances that delineate and disseminate<br />
the successful saga of her corporate world <strong>going</strong> hammer<br />
and tons and doing exceptionally well, seem to be the<br />
most obvious reasons which have made her a prominent<br />
economy on the <strong>global</strong> map today.<br />
<strong>The</strong>re is no company in the fortune 500 list, which<br />
does not want to do business either with India or inside<br />
India. Ranging from IT titans like Microsoft, IBM, Intel,<br />
Dell, to world’s largest retail chain Walmart, Japanese car<br />
manufacturer Hyundai and Toyota to French major Renault.<br />
From biggest telecom company Vodafone to <strong>global</strong><br />
financial institutions like Bank of America, Citigroup,<br />
ABN Amro and HSBC, all of them have announced their<br />
future plans for the country along with the humongous<br />
investments that they intend to make.<br />
And why would any company not contemplate of commencing<br />
its operations or for that matter not want to do<br />
business with India, especially when they get one of the<br />
most educated and well versed workers, with sound knowledge<br />
of the <strong>global</strong> market, at comparatively and relatively<br />
lower price. (According to estimates by the year 2010,<br />
India will have the highest number of English speakers).<br />
Be it world leaders in car manufacturing like the General<br />
Motors or domestic corporate giants like Reliance, Bharti,<br />
Tata et al, they have all been capitalizing on the human resource<br />
available in India for quite a longtime now. And all<br />
the financial accomplishments of these enterprises could<br />
also be attributed to these reasons, which have eventually<br />
helped the country becoming only the 12th nation to cross<br />
the trillion dollar GDP figure.<br />
Going Hammer and Tongs:<br />
Not only this, in the last couple of years the corporate<br />
India has made valuable attempts for expanding<br />
their operations in the overseas market as well and<br />
the recent figures of both inbound as well as outbound<br />
Mergers and Acquisitions(M&As) exemplify<br />
this fact pretty well. In the past 15-18 months, Indian<br />
conglomerates left no stone unturned in acquiring,<br />
merging or tying-up with their foreign comrades<br />
and doing business that could and most certainly<br />
would contribute to India’s economic growth. Taking<br />
full advantage of their company’s strong revenue<br />
base, Indian corporate leaders executed the plans<br />
to acquire and merge with the European giants<br />
(though at times with comprehensive risks, as in<br />
case of Tata-Corus or Hindalco-Novelis deals) in order<br />
to have an access to markets abroad.<br />
According to the Grand Thorton report, the total<br />
number of deals that took place in the year 2006 was 782<br />
as compared to 467 in 2005, out of which 480 were M&A<br />
deals and the rest 302, the private equity ones. Altogether<br />
there were 480 M&A deals with a total value of about<br />
$20.3 billion in 2006 with an average deal size of $42<br />
million. Going by the sectoral examples, IT happened to<br />
be the leading one, which garnered $2.9 billion worth of<br />
deals. <strong>The</strong> major deals in that segment included EDS’s<br />
acquisition of majority stake in Mphasis BFL, RR Donnelley’s<br />
acquisition of Office Tiger, i-Flex’s acquisition of<br />
Mantas Inc etc.<br />
Additionally, there were 8 deals of over $500 million<br />
(excluding Tata-Corus), of which Dr. Reddy’s Laboratories<br />
acquisition of Betapharm, Suzlon Energy’s of Hansen<br />
and Citigroup’s increasing stake in HDFC were both the<br />
biggest as well as the most talked about ones. <strong>The</strong> report<br />
further divulges that IT leads the M&A volume proportion<br />
with its 20 percent share of total number of M&A deals,<br />
while Pharma, Healthcare & Biotech contributed to the<br />
second highest share at 10.4 percent.<br />
<strong>The</strong> cross border deals significantly increased to 266<br />
with a consequent appreciation in the worth thereby reaching<br />
a whopping $15.3 billion last year as against 192 deals<br />
with a total worth of $9.5 billion in 2005. Where at one<br />
hand there has been a phenomenal growth rate in outbound<br />
deal value as well as volume, inbound deals have<br />
remained almost the same as compared to the year 2005.<br />
<strong>The</strong> largest outbound acquisitions have been in Europe,<br />
which accounts for 42 percent of the deal value, followed<br />
by North America with 24 percent. United States and<br />
United Kingdom are the two countries that garnered the<br />
maximum outbound deal share, at 29 percent of the total<br />
deal value.<br />
Sectorwise Break up- M&A Deals by Value Mar-Apr 2007<br />
Source: Grant Thornton<br />
July-October - 2007 Need the Dough<br />
35
TRENDS<br />
During the last financial year the total number of M&A<br />
deals that took place in India was worth $47 billion, out<br />
of which $20 billion were spent on outbound deals (nearly<br />
five-times of what happened in the year 2005). Furthermore,<br />
if the forecast by McKinsey & Company is taken into<br />
account, India will see overseas-M&A activity of about<br />
$30-36 billion this year, out of which deals worth some $10<br />
billion have already been completed. During the period of<br />
last 15 months, the Private Equity investments in Indian<br />
companies have also witnessed a significant growth. From<br />
a monthly rate of 12 deals valued at $200 million in January<br />
2006, PE investments deals’ figures have reached to<br />
45 deals and valued to about $1 billion for the month that<br />
ended March 2007. <strong>The</strong> total deal value has increased from<br />
merely $2 billion in 2005 to $7.8 billion in 2006 and to $3.5<br />
billion for the Jan-April 2007 period. But if all the M&A<br />
activities are observed from the <strong>global</strong> perspective, our<br />
motherland is far behind that of the rival sister countries.<br />
India’s contribution to the <strong>global</strong> M&A-spend of nearly<br />
inbound cross border deals has been 17 with a total value<br />
of $1.98 billion. While the numbers of outbound cross<br />
border deals were 32 with a value of $3.41 billion.<br />
In the month of April 2007, Indian companies announced<br />
scores of M&A deals. <strong>The</strong> largest being the Essar<br />
Steel-Algoma deal, where Ruias owned Essar Steel<br />
declared that it would acquire Canadian Algoma Steel for<br />
1.8 billion Canadian dollars (approx $1.58 billion) which<br />
is to be paid in cash. Algoma Steel had steel shipments of<br />
2.4 million tons in 2006 thereby generating a revenue of<br />
1.9 billion Canadian dollars.<br />
M&A deals like Tata Power’s stake in PT Kaltim Prima<br />
Coal and PT Arutmin Indonesia, Vedanta Resources’ buying<br />
out majority stake in Sesa Goa, Matsushita’s majority<br />
stake in Anchor Electricals, Ranbaxy Laboratories’ 14.9<br />
percent share in the Hyderabad-based Jupiter Bioscience,<br />
Cadila Healthcare’s 100 percent acquisition in Tokyoheadquartered<br />
Nippon Universal Pharmaceutical for an<br />
undisclosed sum, Jubilant Organosys’ share in US-based<br />
Certainly there is a huge scope ahead<br />
for the Indian majors, but one should<br />
never forget that everything comes at a<br />
particular cost, and it’s the risk associated<br />
$4 trillion has been merely<br />
over 1 percent, which is<br />
anything but sufficient.<br />
If the growth in the individual<br />
sectors is taken<br />
into account, investments<br />
in real estate, financial<br />
services, media & entertainment,<br />
to name a few,<br />
have seen quite a high<br />
growth. For example, investment<br />
in real estate has<br />
increased from negligible<br />
values in 2005 to about $1.1 billion in 2006 and crossed the<br />
figure of $680 million in just the Jan-April 2007. Similarly,<br />
investment in Media & Entertainment has gone up from<br />
a figure of $142 million in 2005 to $640 million in Jan-<br />
April 2007 quarter, an average q-o-q increase of 175%.<br />
In the financial services itself the figures have increased<br />
from barely $185 million to as much as $773 million, an<br />
average q-o-q increase of 159% for the same quarterly<br />
period. Altogether, there were 111 M&A deals with a total<br />
value of about $6.12 billion in March and April 2007, out<br />
of which the total number of domestic deals have been<br />
62, with a value of around $0.73 billion. <strong>The</strong> number of<br />
contract research and manufacturing services(CRAMS)<br />
company Hollister-Stier Laboratories LLC for $122.5<br />
million, Wockhardt’s stake in French pharmaceutical<br />
group Negma Laboratories for Rs10.9 billion ($265 million)<br />
and Siemens acquisitions of 77 percent in Chennaibased<br />
iMetrex Technologies, have been the ones to hit<br />
the headlines.<br />
In fact during the first four months of 2007, there were<br />
213 M&A deals with a total value of about $ 42.92 billion.<br />
Of these, the number of domestic deals has been 103<br />
with a value of $ 1.35 billion. <strong>The</strong> number of inbound<br />
cross border deals has been 38 with a value of $ 17.16<br />
billion and the number of outbound cross border deals<br />
was 72 with a value of $24.41 billion, whereas the sectors<br />
garnering the maximum investment during the period<br />
of March and April has been Steel with 25 percent and<br />
Energy with 18 percent.<br />
Need to be circumspect not cynical:<br />
Certainly there is a huge scope ahead for the Indian majors,<br />
but one should never forget that everything comes at<br />
a particular cost, and in this case, it’s the risk associated.<br />
Takeovers are said to be extremely risky and whenever an<br />
individual company has bid for the acquisition, especially<br />
for the one bigger than its own size, it has made an adverse<br />
36 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
effect on the company’s market cap, as the share prices<br />
have always tumbled down with the news.<br />
But why does this at all happen Does one think that<br />
by investing upon an idea to take over a foreign major<br />
or a domestic one, especially which has not been doing<br />
good for the past some time, companies are gambling with<br />
the investors’ as well as their own funds Perhaps Yes!<br />
Perhaps Not! Share holders of a company are the people<br />
who have accepted to take the risk associated with the<br />
company on their own choice. When during good times<br />
they never miss an opportunity to earn on whatever they<br />
have invested, why should they not be prepared for the<br />
loss <strong>The</strong>y must at least bear with the company till the<br />
volatile period passes by, or shouldn’t they<br />
Well, that is something that cannot be not be answered,<br />
at least for the time being, but something that can be<br />
answered is that upto what extent taking risks by these<br />
enterprises is justified. It is clear that more risk is involved<br />
in the M&A cases where debt-equity ratio of the company<br />
being acquired or taken over is high, (as has been in the<br />
case of Novelis). Also, instances in which the deal is considered<br />
overpriced, apprehensions go up, be it in analyst’s<br />
mind or shareholders’ (as has been in the case of Corus,<br />
where the deal bagged was considered to be the winning<br />
curse for the Tatas).<br />
Actually there are very few, who are able to understand<br />
that these acquisitions are done keeping in mind the long<br />
term benefits. Most of them who land up commenting<br />
unnecessarily, do so because either they overlook those<br />
benefits, partially because they are oblivious and rest because<br />
of their inability to understand the benefits that lie<br />
beneath those deals. In case of Birlas’ bid for Novelis, a<br />
Canadian debt laden Aluminum producer, that accounts<br />
for almost 19% of the world’s Aluminium market; the deal<br />
was condemned by a consortium of invest bankers and<br />
business tycoons. Following the foot steps of Tatas’, when<br />
Hindalco’s chairman Kumar Mangalam Birla announced<br />
of the $6 billion acquisition, which they believe would<br />
double the turnover of Aditya Birla group to over $20<br />
billion, they faced terrible opposition by the investors as<br />
a result of which their share prices declined miserably.<br />
In fact, Novelis was a much risky game than Corus, as<br />
on a net worth of $322 million, company had a debt of<br />
nearly $2.33 billion with a debt equity ratio of 7.23:1. Even<br />
analyst reports said Birlas are taking too high a risk to enter<br />
into fortune 500 list and this sort of buyout would reduce<br />
Hindalco’s earnings per share by 25 percent. But there<br />
was something in this acquisition that only the authorities<br />
at the Aditya Birla group could see, something that was<br />
worth taking the risk! <strong>The</strong> authorities revealed, “Novelis<br />
brings with it technology, which Hindalco would take 10<br />
years to develop on its own. Moreover it would cost nearly<br />
$12 billion for Hindalco to build assets that would match<br />
Novelis’ 29 plants in 4 continents with current production<br />
of 3.3 million tons”.<br />
Some similar apprehensions were raised when the deal<br />
of Corus, when an equity value of $12.1 billion was at the<br />
verge of being materialized. After several rounds of revised<br />
bids Tata Steel finally managed to defeat its Brazilian competitor<br />
and what commenced as an amicable bid for the<br />
world’s ninth largest ‘Corus’, culminated into a corporate<br />
war with Brazilian giant CSN. Projections divulged that<br />
the Tata-Corus entity together would produce some 23.5<br />
million tons of steel and would become the fifth largest<br />
steel producer of the world, post merger. But instead of<br />
the move to acquire Corus being appreciated, it was considered<br />
over priced and reservations were raised on the<br />
company’s future, until recently, when Tatas steel posted<br />
a net PAT of around $ 950 million.<br />
Before condemning any act we fi rst need to analyze as<br />
well realize the vision with which it was taken. No decision<br />
is good or bad in the world of business, it’s the outcome<br />
of the decisions taken which makes it good or bad. If a so<br />
called bad decision creates maximum shareholders wealth,<br />
it would be considered a good one. Quite evident is the<br />
fact that when ever two companies, one doing fi nancially<br />
well and the other not, have formed an alliance, people,<br />
market and all the experts have resisted to their coming<br />
together, as compared to the merger of two well performing<br />
enterprises. Just take the instance of Exxon and Mobil<br />
coming together to form ExxonMobil, world’s biggest oil<br />
company with a massive revenue base of over $365 billion<br />
(figures as per the 2006 Company’s Annual Report) or for<br />
that matter the merger of United States’ second biggest oil<br />
corporation ConocoPhilips, created through the combination<br />
of Conoco Inc. and the Phillips Petroleum Company<br />
in 2002. In both these cases, there were apprehensions<br />
(though in the minds of few), but people were not so cynical<br />
about these strategic combination.<br />
Eventually it’s your call:<br />
Also one must not forget, that all these M&A decisions,<br />
taken on the advice of world class consortium of Investment<br />
Bankers, who charge nearly one percent of the<br />
billions of dollar worth deals, can not simply be called<br />
imprudent, just because they lack the short-term gain and<br />
involve a comprehensive amount of risk. Although we<br />
have witnessed more failures than success in M&A deals<br />
in the recent past, that does not at all not mean that most<br />
M&As would simply not work. Hence the debate is on!<br />
Should people simply sit back and enjoy the token return<br />
on their investment by not taking any risk or should they<br />
look forward to earning big bucks by supporting the company<br />
in time of need.<br />
<br />
July-October - 2007 Need the Dough<br />
37
IN FOCUS<br />
INDIA INC. GOING<br />
G L O B A L<br />
<br />
<br />
India Inc.’s <strong>global</strong> ambitions are on a new high with year-to-date<br />
overseas acquisitions worth more than $28 billion compared with<br />
just $4 billion in the corresponding period of the calendar year in<br />
2006 and more than twice achieved in the whole of last year. Transactions<br />
include the acquisition of the U.K.’s largest steel maker Corus<br />
Group Plc by India’s Tata Steel Ltd; the acquisition of Hutchison Essar<br />
Ltd India’s second largest GSM mobile service provider by the U.K.’s<br />
Vodafone Group Plc; India’s largest non-ferrous metals company Hindalco<br />
Industries Ltd’s acquisition of Atlanta-based Novelis Inc. and<br />
Suzlon Energy Ltd’s acquisition of German wind turbine company<br />
REpower Systems AG.<br />
If that was not enough, we have the bidding war round the corner<br />
for Jaguar and Land Rover, the U.K. based iconic marques owned by<br />
Ford Motor Company, the U.S. based world’s third largest automaker,<br />
for an estimated price upward of $2 billion, which features Tata Motors<br />
Ltd, India’s biggest automobile company, and Mahindra & Mahindra<br />
38 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
Ltd, tractor & utility vehicle manufacturer, among others.<br />
<strong>The</strong>se deals are symbolic of the evolving Indian businesses<br />
making a mark in the <strong>global</strong> market place.<br />
Investment Scenario:<br />
SIX MONTHS (JAN-JUNE) OF CY 2007<br />
• No. of Merger & Acquisition Deals : 339<br />
• Total value of deals $44 billion<br />
• Number of domestic deals have been 167<br />
• Value of domestic deals $1.6 billion.<br />
• <strong>The</strong> number of inbound cross border deals: 51<br />
• Value of inbound deals $14.5 billion<br />
• <strong>The</strong> number of outbound cross border deals: 121<br />
• <strong>The</strong> value of outbound deals : $28 billion<br />
• Private Equity investments : $6.8 billion<br />
Deals - January to December 2006:<br />
• Total deal value $28 billion, a growth of 54% compared<br />
to $18 billion in 2005<br />
Mergers & Acquisitions - $20 billion through 480 deals,<br />
growth of 24%<br />
• Cross border deals - $15 billion through 266 deals<br />
• Inbound deals - $5.4 billion through 76 deals<br />
• Outbound deals - $10 billion through 190 deals<br />
• Private Equity investments $8 billion, compared to just<br />
$2 billion the previous year<br />
• Foreign Direct Investment - $12.5 billion (April – January<br />
2006-07)<br />
Volume to Value Game: Go Global<br />
On the other hand, the increase in deal values, with the<br />
average deal size for M&A deals increasing to $130 million<br />
in H1 2007 from $48 million for the same period<br />
last year points to the fact that the year 2007 is on track<br />
to be a year of ‘mega deals’. <strong>The</strong> deals so far have already<br />
captured more than $40 billion, twice as much as last<br />
year and four times more when compared<br />
to the corresponding period.<br />
While last year the focus was on the<br />
volume of deals, 2007 will be more<br />
value driven and is expected to touch<br />
the $100 billion mark.<br />
<strong>The</strong> key to these mega deals is not to<br />
provide short-term increase in earnings<br />
per share or for that matter, a great yield of shareholder<br />
value because there is too much risk involved. <strong>The</strong>re is risk<br />
of the price being paid, as the valuations of the acquired<br />
companies could be far in excess of those of the acquiring<br />
companies. And the biggest risk in M&A deal is not the deal<br />
itself, it is the post merger integration and there is still a lot<br />
of lack of experience in Indian companies. As ambitious<br />
as they are, they are not quite <strong>global</strong> as yet.<br />
Inorganic paths are<br />
the way to get the<br />
scale and the longterm<br />
benefits<br />
Having said that, if Indian companies want to go <strong>global</strong><br />
and do want to hit the kind of scale you see, not just from<br />
the top companies in India, but <strong>global</strong>ly fortune 100 companies,<br />
you have to buy that growth.<br />
Tata Steel could not have gone from six million tonne<br />
capacity to 25 million tonne without acquisitions. Inorganic<br />
paths are the way to get that scale and the long-term<br />
benefits, even mid-term benefits will be there provided you<br />
can get the cost rationalization, the synergies, and the full<br />
through effect on the bottomline and therefore a positive<br />
effect on EPS.<br />
<strong>The</strong> Risk Effect:<br />
<strong>The</strong> immediate reaction to such deal announcements is the<br />
‘Stock Prices’ of the acquiring companies drop as investors<br />
perceive a high degree of risk in the acquisitions and<br />
a premium price being paid by Indian companies a bit too<br />
high. Investors tend to be cautious, as I said the biggest risk<br />
in merger & acquisitions (M&A) deals were not the deals<br />
themselves, but the post-merger integration.<br />
Notwithstanding the negative short-term reaction, there<br />
are obvious long-term benefits of achieving <strong>global</strong> scale<br />
– new markets and new customers; high-end intellectual<br />
property of either process technology or product technology<br />
patterns of some kind and skill-sets. Such acquisitions also<br />
add incremental value to the acquirer’s brand, the ability to<br />
serve the customer close to a point of need and of course,<br />
getting economies of scale. This in the present day can<br />
be achieved through inorganic means and that attracts a<br />
premium.<br />
Premium Justified:<br />
<strong>The</strong> premiums paid are, in some way, a bet on the execution<br />
capabilities of the acquiring company to get those cost<br />
synergies. <strong>The</strong> one company I would bet on being able to<br />
get the integration cost down is Tata Group. It is a company<br />
that has been brilliant in execution pretty<br />
much so far. <strong>The</strong>y have paid a premium<br />
price, probably very close to the top end<br />
of their desired price for Corus Group<br />
Plc, but Tatas have the recognition that<br />
the world is getting smaller and if they<br />
want to be <strong>global</strong>ly competitive, they<br />
have got to keep up with the likes of<br />
Arcelor-Mittal, the world’s largest steel maker formed as<br />
a result of the merger of Arcelor S.A. with Mittal Steel<br />
Company, N.V. in 2006.<br />
At the high end of any price, and that goes pretty much<br />
across the board whether it is the deals by Aditya Birla<br />
Group, Tata Group or Vodafone and Suzlon Energy, all<br />
those deals are critically dependent on the post-merger integration<br />
strategies.<br />
July-October - 2007 Need the Dough<br />
39
IN FOCUS<br />
If they can successfully do that, then they have got cost<br />
rationalization, but there is no one in the market who would<br />
say today that they have paid a cheap price. If Indian companies<br />
want to buy companies which are cheap, then they<br />
are looking at companies that are not hugely profitable or<br />
not profitable at all. So the result of that is, they are not<br />
buying either a very healthy company or by buying a less<br />
profitable company, they take the earnings per share dilution<br />
upfront.<br />
One World:<br />
<strong>The</strong> other aspect is the growing prominence of the cross<br />
border deals which highlight the growing intimacy between<br />
two economies or regions. <strong>The</strong> acquisition of Hutchison<br />
Essar Ltd by the U.K.’s Vodafone Group Plc reinforces the<br />
reciprocity between Indian and the U.K. companies seeking<br />
to unlock the potential in emerging economies on one hand<br />
and harnessing the size and scale of <strong>global</strong> operations on the<br />
other as shown by the acquisition of the U.K.’s largest steel<br />
maker Corus Group Plc by India’s Tata Steel Ltd.<br />
Indo-Europe Trade:<br />
• Indo-Europe trade by 2010 to touch $100 billion from<br />
$20 billion currently<br />
• Indo-French trade to touch $10billion by 2010 from $3.5<br />
billion currently<br />
• India among top 10 investors in U.K. in 2006-07<br />
• No. of Indian companies in London : 500<br />
• Listed companies : 30<br />
• New Projects financed : 69<br />
• New jobs created : 5,130<br />
• <strong>The</strong> largest proportion of outbound acquisitions (Indian<br />
companies acquiring companies overseas) have been in<br />
Europe - 57% of deal value this year<br />
Indo-U.S. Trade:<br />
• Trade volume of $30 billion in 2006-07<br />
• U.S. accounts for 16.8% of Indian exports and 6.3% of<br />
its imports<br />
• India-U.S. bilateral trade expected to double by 2009<br />
• North America accounted for 34% of the outbound<br />
acquisitions this year<br />
• 46 outbound investment deals from India to the U.S.<br />
amounted to the total value of more than $2 billion<br />
during the financial year 2006-07<br />
• 48% of the deals were in the Information Technology<br />
(IT) and IT-enabled Services (ITeS) Pharma & Healthcare<br />
accounted for 9% and Gems & Jewellery registered<br />
7% deals<br />
• Indo-U.S. Nuclear deal expected to open a lucrative<br />
market for nuclear energy equipment makers<br />
Trade between India and Europe is expected to multiply<br />
five times to $100 billion by 2010 from current level<br />
of $20 billion, according to industry estimates. Propelling<br />
this growth is increasing merger and acquisition activity<br />
between companies in the two regions. Acquisitions by<br />
Indian companies in Europe accounted for 57% of the<br />
total acquisitions made overseas so far this year amounting<br />
to about $16 billion, up from just $4 billion in whole<br />
of last year.<br />
<strong>The</strong> investments by India Inc. in Britain during the fiscal<br />
year 2006-07 has created 5,130 jobs, second to the U.S., according<br />
to the U.K.’s Department of Trade and Industry.<br />
In terms of the number of new projects, India has been<br />
ranked third with 69 new projects, after 540 new projects<br />
of the U.S. and 95 new projects of France.<br />
Further, an India-strategy for a <strong>global</strong> company in the<br />
overall business plans takes precedence in its inorganic<br />
growth as well. A point highlighted in the recent acquisition<br />
by French IT services company, Groupe Steria of U.K.-<br />
based Xansa Plc., which has more than 5,000 employees in<br />
India out of its total headcount of 8,000.<br />
<strong>The</strong> deal follows the footsteps of the acquisition by<br />
Capgemini SA, Europe’s biggest computer-services company<br />
of Rosemont, Illinois-based Kanbay International Inc.,<br />
provider of IT services for banks and financial institutions<br />
for $1.25 billion in the last week of October 2006. <strong>The</strong><br />
combined entity today has about 17,000 employees in India,<br />
representing 22% of Capgemini’s total workforce.<br />
Sectors to Watch<br />
Information Technology:<br />
It is difficult to ignore a market that offers the best of the<br />
three key location-based advantages: a skilled workforce,<br />
lower costs and growing domestic market.<br />
India’s information technology (IT) and IT services industry<br />
became the most consolidating industry with 97 mergers<br />
and acquisitions (M&A) deals worth almost $3 billion last<br />
year. This year so far the sector has already witnessed 75<br />
M&A deals, a growth of 22% when compared to the corresponding<br />
period last year worth more than a billion dollars<br />
in just half a year matching the deal making last year.<br />
Going ahead, we are expecting to see continued growth<br />
in the IT services sector. Software and related services exports<br />
are expected to touch $21 billion in 2007, a growth<br />
of 21.6%. Business process outsourcing is also expected to<br />
increase by 34% to reach at $12.6 billion in 2007.<br />
Automotive Sector:<br />
<strong>The</strong> Indian automotive sector, characteristically driven<br />
by traditional and conservative business conglomerates is<br />
under-<strong>going</strong> a fundamental shift as companies set out to<br />
unlock the benefits of <strong>global</strong> scale of operations exhibited<br />
by the increasing merger & acquisition (M&A) deals in the<br />
40 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
sector worth more than $515 million from 17 deals so far<br />
this year, i.e. almost equal to the value and volume of deals<br />
done by the sector in the whole of last year.<br />
<strong>The</strong> Indian auto component industry is likely to almost<br />
double to $18.7 billion by 2009 and reach about $40 billion<br />
by 2014. India is expected to move ahead of the U.K. and<br />
Canada as a car-producing country by 2008. Its car production<br />
capacity is expected to surpass 2 million units by 2008<br />
from the current capacity of more than 1.4 million units.<br />
It has already surpassed Korea to become the third largest<br />
car market in Asia-Pacific after China and Japan.<br />
Pharmaceutical Sector:<br />
<strong>The</strong> <strong>global</strong> ambition of Indian companies, underpinned by<br />
unprecedented overseas acquisitions, is now playing out in<br />
the pharmaceutical industry. <strong>The</strong> increase in worldwide<br />
M&A activity in the pharma-sector is attributed to the expected<br />
market growth as drugs worth $65 billion in sales<br />
go “off patent” next year.<br />
<strong>The</strong> pharma sector accounted for second most M&A<br />
deals worth $2.5 billion in 2006 compared with just $364<br />
million the previous year. In the current year the sector<br />
has already seen M&A deals worth more than $1 billion<br />
from 34 deals.<br />
Indian companies are strongly positioned to grab the<br />
new opportunities in the generic drug market as they have<br />
the benefit of low-cost manufacturing, world-class production<br />
skills and availability of quality manpower. Domestic<br />
production costs in India are almost 50% less compared<br />
to developed countries.<br />
<strong>The</strong> progressive trend in this sector is expected to continue,<br />
due to increased integration with <strong>global</strong> trade which<br />
began with the signing of the General Agreement on Tariffs<br />
and Trade (GATT) in January 2005. India started to recognise<br />
<strong>global</strong> patents and the growing significance of the<br />
country in terms of contract research and clinical trials.<br />
Indian drug-makers are expected to acquire a 33% share<br />
of the <strong>global</strong> generic drug market in the next two years<br />
against the current 4% market share, according to industry<br />
estimates.<br />
Retail sector:<br />
<strong>The</strong> Indian retail market worth $250 billion is expected to<br />
grow at a compounded rate of 30%, in the next five years.<br />
It is fast becoming an area of growing interest among <strong>global</strong><br />
retail companies. Wal-Mart Stores Inc., the world’s largest<br />
retailer, recently announced a joint venture with Bharti<br />
Enterprises, the parent company of Bharti Airtel Ltd, the<br />
largest mobile telecom service provider in the country.<br />
<strong>The</strong> agreement is expected to catalyze the growth of<br />
“organised retail” in India, which will require investments<br />
of about $60 billion by 2010, according to estimates from<br />
Department of Industrial Promotion and Policy, Ministry of<br />
Commerce & Industry, Government of India. <strong>The</strong> segment<br />
growing at the rate of 25%-30% a year is expected to see its<br />
share in the total Indian retail market grow to 15%-20% in<br />
the next decade from the current 2%.<br />
While <strong>global</strong> companies like Wal-Mart are lining up to<br />
grab a share of the pie, domestic companies such as Pantaloon<br />
Retail (India) Ltd (currently Future Group), country’s<br />
leading retail company with more than 100 stores in 30<br />
cities and Shoppers’ Stop, the largest retail stores chain in<br />
India have taken the lead in showcasing modern retail to<br />
the Indian consumer.<br />
<strong>The</strong>y are followed by India’s largest industrial conglomerate<br />
Tata Group with its subsidiary Trent Ltd that operates<br />
Westside, one of India’s leading chains of retail stores for<br />
garments; Reliance Industries Ltd., India’s most valuable<br />
firm with a market value of Rs. 3,872.01 billion and diversified<br />
Aditya Birla Group have made their retail forays<br />
respectively. While the early movers will have an advantage,<br />
the opportunities in the market are big enough to accommodate<br />
others who follow.<br />
Real-Estate:<br />
With a housing requirement of 80 million units over the<br />
next 15 years and 200 million square feet in office space required<br />
over the next five years by the country’s Information<br />
Technology and Business Process Outsourcing industries<br />
alone, India’s real estate market is expected to be worth $50<br />
billion in 2010 from $14 billion this year.<br />
General Electric Company (GE), the world’s second largest<br />
company by market value, is boosting its commitment<br />
to India’s real estate market by allocating $2 billion for<br />
real estate projects such as townships, special economic<br />
zones (SEZs), information technology (IT) parks, retail<br />
and residential developments.<br />
Amid apprehensions and caution from some stock market<br />
analysts, demand for shares for the $2.4 billion Initial<br />
Public Offering (IPO) by DLF Ltd, India’s largest real estate<br />
company, exceeded supply by two times.<br />
Also, the new guidelines for Real Estate Mutual Funds<br />
(REMFs) issued by the Indian stock market regulator Securities<br />
and Exchange Board of India (SEBI) have opened<br />
new vista of investment opportunities for mutual funds in<br />
Indian real estate.<br />
Such an initiative by the regulator and industry growth<br />
trends have found many takers as overseas funds of about<br />
$7 billion have been announced so far for investment in<br />
Indian real estate. Foreign Direct Investments (FDIs) are<br />
estimated to reach 16 billion by 2012 from just $600 million<br />
last year. <strong>The</strong> sector has also seen its share of inorganic<br />
activity with M&A deals worth more than $500 so far this<br />
year compared to just negligible deal activity last year. <br />
July-October - 2007 Need the Dough<br />
41
IN FOCUS<br />
M&A<br />
in the<br />
INDIAN BANKING<br />
INDUSTRY<br />
According to Indian Bank’s Association Banking<br />
Industry Vision 2010, mergers and acquisitions<br />
would gather momentum as managements strive<br />
to meet the expectations of stakeholders<br />
42 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
<br />
<br />
<br />
Consolidation is a dominant feature of the banking<br />
sector in most countries today. A major<br />
Process of Mergers and Acquisitions (M&A) has<br />
helped in consolidation of the banking industry. Most<br />
large banks in the world have been acquiring repeatedly<br />
smaller and larger banks in their countries and elsewhere<br />
and the process of integration has been generally smooth<br />
and successful. This has given a further impetus to this<br />
the consolidation activity in banks through M&A. While<br />
a merger involves a marriage of two or more banks, an<br />
acquisition involves one bank taking over ownership of<br />
the other. It is generally accepted that mergers and acquisitions<br />
promote synergies and economies of scale. <strong>The</strong><br />
basic idea is that the combined entity will create more<br />
value than the individual banks operating independently<br />
not only for the stakeholders, but also for customers and<br />
the industry in general.<br />
In Asia, Malaysia has reduced the number of banks<br />
from 55 to 10, Taiwan is working towards bringing down<br />
the number of state banks from to 6 from 12 this year<br />
and the Singapore Government has guided the system<br />
down to three players with DBS being supported to<br />
become a regional leader. Similar initiatives are being<br />
taken in Indonesia, South Korea and Japan.<br />
Only 22 of the Indian banks figure among the top<br />
1,000 banks in the world. In Asia, State Bank of India<br />
(SBI), the largest in India, is the only entity that has made<br />
it to the top-25 list. In comparison, China’s fourth-largest<br />
bank is 2.5 times that of SBI. <strong>The</strong> market capitalization<br />
of the entire Indian banking sector is about $40-45 billion,<br />
which would make the entire Indian banking sector<br />
rank after the 30 largest banks in the world.<br />
<strong>The</strong> present capital structure of public sector banks<br />
will make them vulnerable to takeovers unless M&As<br />
take place on a significant scale. It is necessary for Indian<br />
banks to complete these M&A activities by 2008-09, to<br />
ensure that they have the strength and size to take on<br />
competition from foreign banks, once sector opens up<br />
almost completely to foreign banks.<br />
Foreign banks are eagerly waiting for the regulator<br />
to open up the sector in April 2009, when RBI is set to<br />
review bank ownership norms. Meanwhile, these banks<br />
are gradually buying minor stakes upto permitted levels<br />
in local banks and also setting up non-bank finance<br />
companies (NBFCs), which can perform most banking<br />
functions except for opening and maintaining savings<br />
bank accounts.<br />
Just as in any other sector, consolidation in the banking<br />
industry, in India and elsewhere, provides for value<br />
maximization as well as non-value maximization and is<br />
also of great relevance for the long term growth prospects<br />
of the national economy.<br />
<strong>The</strong> major gains perceived from bank consolidation<br />
are the ability to withstand the pressures of emerging<br />
<strong>global</strong> competition, to strengthen the performance of<br />
the banks, to effectively absorb the new technologies<br />
and demand for sophisticated products and services, to<br />
enable funding for major development products in the<br />
realm of infrastructure, telecommunication, etc. which<br />
require huge financial outlays and to streamline human<br />
resources functions and skills in tune with the emerging<br />
competitive environment.<br />
Also, Basel II norms on capital adequacy, capitalization<br />
and risk management, which will require banks to<br />
have minimum CAR of 12.5% as against the present<br />
9%, will encourage the banks to move towards consolidation.<br />
Profit maximization is no longer the only objective<br />
No. of M&As<br />
35<br />
30<br />
25<br />
20<br />
15<br />
10<br />
5<br />
M&A Activity before Nationalisation of Indian Bank:<br />
0 1961 1962 1963 1964 1965 1966 1967 1968 1969<br />
Source : Banknet India<br />
for banks, wealth maximization (that is increasing the<br />
wealth of shareholders) and protecting the interest of<br />
shareholders by ensuring financial stability is the new<br />
goal. Consolidation will enable banks to have a much<br />
stronger balance sheet thereby increasing value to shareholders.<br />
July-October - 2007 Need the Dough<br />
43
IN FOCUS<br />
Mergers and amalgamations are not new to the Indian<br />
banking system. However, it is pertinent to note that a<br />
majority of such mergers undertaken by public sector<br />
banks were backed more by because of political reasons<br />
than by commercial ones.<br />
<strong>The</strong> HDFC Bank-Times Bank merger, which became<br />
effective 26 February 2000, was the first market-led<br />
M&A Activity after Nationalisation of Indian Bank:<br />
25<br />
20<br />
15<br />
10<br />
5<br />
No. of M&As<br />
0<br />
1970-79 1980-89 1990-99 2000-07<br />
Source : Banknet India<br />
merger on the Indian banking scene in recent times.<br />
<strong>The</strong> merger had quite a few firsts to it. For one, two new<br />
age private banks, both barely five years old, were joining<br />
hands. Two, the merging banks had reasonably similar<br />
profiles and the deal was settled through a share swap.<br />
<strong>The</strong> Trend of Acquisitions in Cooperative Banks in<br />
India is growing and one major reason for the same is<br />
the RBI restrictive policy on issuing branch licenses for<br />
co-operative banks.<br />
An important observation which may be induced from<br />
various past mergers is that a merger between big and<br />
small banks has led to greater gains as compared to a<br />
merger between equals. It is also observed from past<br />
experiences that if the merger follows business aided by<br />
appropriated technology and diversified product range,<br />
it could lead to greater gains for the banking industry<br />
as a whole. Similarly, consolidation increases the market<br />
power and does not cause any damage to the availability<br />
of services to small customers.<br />
Banks in India are gradually <strong>going</strong> for- 1) Consolidation<br />
of players through mergers and acquisitions, 2)<br />
Globalization of operations, 3) Development of new<br />
technology and 4) Universalisation of banking.<br />
Mergers and acquisitions invite litigation and at the<br />
same time involve substantial time and money for the<br />
parties involved. ”Strategic Business Alliance” although<br />
a new concept, promises a good alternative. A good<br />
example of this is the strategic alliance entered into by<br />
Corporation Bank, Oriental Bank of Commerce and<br />
Indian Bank in 2006 for sharing of information, IT<br />
infrastructure, Training, ATMs, Treasury, Loans etc.<br />
Consolidation would and is taking place not only in the<br />
structure of banks, but also in the area of services. For<br />
instance, some banks would like to shed their non-core<br />
business portfolios to others. This could see the emergence<br />
of niche players in different functional areas and<br />
business segments such as housing loans, cards, mutual<br />
funds, insurance, sharing of their infrastructure including<br />
ATM Network, etc.<br />
Structure and ownership pattern would undergo<br />
changes. <strong>The</strong>re would be greater presence of international<br />
players in the Indian financial system. Similarly, some<br />
of the Indian banks would become <strong>global</strong> players.<br />
According to Indian Bank’s Association Banking<br />
Industry Vision 2010, mergers and acquisitions would<br />
gather momentum as managements strive to meet the<br />
expectations of stakeholders. This could see the emergence<br />
of 4-5 world class Indian Banks. As banks seek<br />
niche areas, we could see emergence of some national<br />
banks of <strong>global</strong> scale and a number of regional players.<br />
Global banks are jostling to gain a foothold in the<br />
Indian market as the $1 trillion economy is continuing<br />
to grow at a brisk pace offering enormous opportunities.<br />
All of them want to party in the world’s fastest growing<br />
banking market. According to PricewaterhouseCoopers,<br />
India could emerge as the third largest domestic banking<br />
market in the world by 2040 and, in the long run, could<br />
grow faster than China.<br />
Mergers and acquisitions in the banking sector are<br />
<strong>going</strong> to be the order of the day. India is slowly but<br />
surely moving from a regime of `large number of small<br />
banks’ to `small number of large banks’. <strong>The</strong> new era<br />
in banking in India is <strong>going</strong> to be one of consolidation<br />
around identified core competencies.<br />
<br />
Reference:<br />
Banknet’s Handbook on M&A in Indian Banking System-<br />
Second Edition July 2007. Banknet’s Handbook<br />
on M&A is a comprehensive guide to bank mergers &<br />
acquisitions in India. It covers Indian banking structure,<br />
Bank mergers in India since 1961, Essentials of M&A,<br />
Indian legal framework, Procedure, Guidelines for bank<br />
mergers, RBI’s review process, Accounting, Taxation &<br />
Valuation, Case studies and much more.<br />
** Banknet Group, promoted and managed by senior<br />
bankers is focused on disseminating banking and financial<br />
information through online, offline, print and<br />
mass media. BanknetIndia.com is ranked among the Top<br />
25 banking sites and Top 20 banking technology sites<br />
and resources online in the world. Banknet Conferences<br />
are one of the largest organizers of highly focused and<br />
topical banking conferences, seminars in India. Banknet<br />
Publications are based on extensive industry research,<br />
surveys and interactions with practicing industry<br />
professionals.<br />
44 Need the Dough July-October - 2007
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IN FOCUS<br />
Corporate Consolidation<br />
Activities–Indian Perspective<br />
<br />
<br />
<br />
<br />
<br />
<br />
46 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
Baffled Consider this – `Have cash, will buy` - the<br />
breezy motto of India Inc. Deal mania has gripped<br />
India Inc. Every week seems to bring news of some<br />
headline-grabbing deal or the other. In June 2007, total<br />
value of overseas deals by Indian Companies exceed inbound<br />
deals with an average deal size of $107 mn. <strong>The</strong><br />
malaise that had gripped Deal Street till is now a distant<br />
memory. <strong>The</strong> economy is on steroids and capital is furiously<br />
coursing through its veins - it could be a corporate M&A,<br />
PEs, IPOs. Business assets are being bought and sold like<br />
never before. And, to add a happy twist, wannabe Indian<br />
MNCs are picking up targets in the US, Europe and Asia.<br />
`M&A is now a core art of India Inc`s growth strategy` – is<br />
the conclusion of survey-based report of AT Kearney and<br />
the Wharton School of University of Pennsylvania. Using<br />
financial data from 10,000 corporates over a span of three<br />
years, they showed that 72% of India Inc`s value growers,<br />
those who have grown both in terms of revenue and shareholders<br />
value, have employed an M&A led strategy. Grant<br />
Thornton India in a separate survey-based report concluded<br />
that “81% of respondents look M&A as a part of strategy<br />
or will look at it opportunistically.”<br />
Why has there been a spurt in deals in the recent years<br />
<strong>The</strong> red-hot economy is the obvious starting point. India is<br />
likely to end the year with GDP growth in excess of 9 per<br />
cent. It will be the third consecutive year of fast growth, a<br />
rarity in our economic history. Confidence<br />
is sky-high. But the mere urge to buy and<br />
merge is not enough. You need money<br />
for the job. Companies and private equity<br />
investors are sitting on large piles of cash.<br />
“Companies focused on restructuring between<br />
1997 and 2003. <strong>The</strong>y cleaned up<br />
their balance sheets. Now, companies are<br />
cash-rich and business confidence is skyhigh.<br />
Add to this the easy availability of funding options and<br />
you have what seems like a winning formula. This explains<br />
the frenzied activity we have witnessed in recent months,”<br />
says Praveen Kadle, Tata Motors’ executive director and<br />
CFO. Truly said, in this era of LPG (Liberalisation, Globalisation<br />
and Privatization) M&A has become a buzzword<br />
in the Indian corporate world today. In mathematics 1 +<br />
1 is always equal to 2 but in corporate world it has always<br />
been an endeavor to make 1+1 =3. This is exactly what we<br />
define as synergy effect. It is the very reason why M&A has<br />
become so popular today.<br />
<strong>The</strong> uphauling of the industrial policies in India’s agenda<br />
for economic reforms has resulted in a radical change of<br />
environment for the private corporate sector, boosting in<br />
the process, a market for corporate control characterized by<br />
M&A and similar corporate consolidation activities. M&A<br />
are undertaken by corporates to achieve certain strategic<br />
<strong>The</strong> real thing<br />
happened in<br />
1991 and old<br />
corporate<br />
empires felt<br />
the heat of<br />
competition...<br />
and financial objectives. <strong>The</strong>y involve the bringing together<br />
of two organizations with often disparate corporate personalities,<br />
cultures and value system. Success of mergers<br />
may therefore depend on how well the organizations are<br />
integrated. <strong>The</strong>re are a variety of stakeholders in the merging<br />
entities that have an interest in the success or mergers.<br />
Shareholders and managers are two critical players of this<br />
corporate strategy but others who have an interest in the<br />
success of mergers include employees, consumers, local<br />
communities and the economy at large. M&A may also<br />
adversely affect competition, an anti-thesis to the movement<br />
of LPG. Though this branch of law is in its infancy<br />
in India, but many countries have an effective mechanism<br />
to regulate corporate consolidations that have anti-competitive<br />
implications.<br />
Burst and Wave Pattern:<br />
One of the striking aspects of mergers and acquisitions as a<br />
phenomenon is that they occur in `Bursts` interspersed with<br />
relative inactivity. This pattern is called the `wave pattern`.<br />
This pattern of M&A has been observed in US for over last<br />
100 years, in the UK from the early 1960s; and continental<br />
Europe very recently.<br />
In Indian context, this is the fourth wave of corporate<br />
deal-making. <strong>The</strong> first wave lapped our shores in the 1980s.<br />
<strong>The</strong> first corporate raiders landed - the likes of Swaraj Paul,<br />
Manu Chhabria and R.P. Goenka. <strong>The</strong> first<br />
mega public issues, too, hit the markets. This<br />
was the era of the first tentative reforms<br />
under Rajiv Gandhi and the birth of largescale<br />
corporate ambition. Companies were<br />
hemmed in by all sorts of licensing restrictions,<br />
and buying a company was one obvious<br />
way to grow. <strong>The</strong> real thing happened<br />
in 1991 and old corporate empires felt the<br />
heat of competition. Conglomerates that had built sprawling<br />
and unfocused business portfolios were forced to sell<br />
non-core businesses that could not withstand competitive<br />
pressures. <strong>The</strong> Tata, for example, sold their soaps business<br />
to Hindustan Lever. That was the second wave of M&As,<br />
largely built on the theme of corporate restructuring. <strong>The</strong><br />
third wave splashed its way through the corporate landscape<br />
after Y2K. <strong>The</strong>re was a round of consolidation in key sectors<br />
like cement and telecommunications. Companies like Bharti<br />
Tele-Ventures and Hutch bought smaller competitors and<br />
built national networks. A new type of deal also made its<br />
presence felt - Venture Capital. Money poured into start-ups,<br />
especially in technology and IT services. <strong>The</strong>re were large<br />
IPOs in this round too. So how is this fourth wave different<br />
from the three previous ones It is the first time that India<br />
has seen so many deals with a <strong>global</strong> flavour. It could be<br />
foreign private equity coming into Indian companies, like<br />
July-October - 2007 Need the Dough<br />
47
IN FOCUS<br />
Newbridge’s investment in Shriram Holdings, Swiss cement<br />
major Holcim’s investment in ACC. Or, most significantly,<br />
a <strong>global</strong> acquisition by an Indian company, like Hindalco<br />
Industries Limited`s (Aditya Birla Group) acquisition of<br />
Novelis for nearly US$ 6 billion, Tata Steel’s purchase of<br />
Corus and NatSteel, or Videocon’s acquisition of the colour<br />
picture tubes business of Thomson, which gave it five<br />
manufacturing and research facilities abroad.<br />
Propellants of M&A and Industry clustering:<br />
Economic scientists suggest that merger waves occur when<br />
a rise in general economic activity creates disequilibrium<br />
in product markets. Some investors hold a more positive<br />
expectation of future demand than others and value target<br />
firms higher. M&A result from attempts to take advantage<br />
of such valuation differences. Once some leading firms<br />
make merger moves, the competitors follow suit and pursue.<br />
Another viewpoint is mergers waves occur due to changes<br />
in Political, Economic, Social and Technical dimensions.<br />
Such changes confer first mover advantages to the firms<br />
that can anticipate these changes or read the implications<br />
HIGH M&A INDUSTRIES<br />
• Pharmaceuticals, Healthcare<br />
• Manufacturing & Engineering<br />
• IT & ITES<br />
• Steel, Cement<br />
• Banking & Financials (investment banks, commercial<br />
banks, insurance companies)<br />
• FMCG<br />
• Power & Oil & Gas<br />
• Construction<br />
• Automotive<br />
• Jewelry<br />
Source: Grant Thornton (India) Survey<br />
of these changes correctly.<br />
One the natural forces of change in an industry is the<br />
product life cycle of that industry e.g. automobiles, chemicals,<br />
IT and ITES, pharmaceuticals etc. As these products<br />
become standardized or commoditized, there is fierce price<br />
competition with the industry characterized by excess capacity;<br />
firms have to merge to `takeout` the excess capacity.<br />
Excess capacity may exist in several forms: in production<br />
capacity, in R&D, in marketing and distribution channels<br />
or in managerial expertise.<br />
Analyzing the size, growth and presence of some leading<br />
corporate groups and presence of some leading corporate<br />
groups in India, it has been observed that these groups<br />
employed M&A strategically to grow and expand. Corporate<br />
groups like RP Goenka (RPG), Vijay Mallya (UB),<br />
Reliance Industries, Murugappa group, Bangur group, Hindustan<br />
Unilever, Ranbaxy, Infosys, Wipro, Sun Pharma, Dr.<br />
Reddy`s Laboratories and Manu Chabria Group employed<br />
M&A strategy aggressively to grow. <strong>The</strong> Ajay Piramal group<br />
was almost entirely built up by M&A.<br />
Legislative impetus to M&A:<br />
<strong>The</strong> terms `merger`, `amalgamation`, `acquisition`, `buyout`<br />
and `takeover` are all part of the M&A parlance. In<br />
a merger, the corporations come together to combine and<br />
share their resources to achieve common objectives. <strong>The</strong><br />
shareholders of the combining firms often remain as joint<br />
owners of the combined entity. In commercial context,<br />
merger and amalgamations are used in the same parlance.<br />
An acquisition resembles more of an arm’s length deal, with<br />
one firm purchasing the assets or shares of another, and with<br />
the acquired firm’s shareholders ceasing to be owners of that<br />
firm. In a merger a new entity may be formed subsuming<br />
the merging firms, whereas in an acquisition the acquired<br />
firm becomes the subsidiary or a unit (separate profit centre)<br />
of the acquirer. A buyout is acquisition of a company or one<br />
of its component businesses and generally implies that the<br />
acquirer is a group of investors including specialist private<br />
equity firms and managers of the business being bought.<br />
In common parlance, a takeover is generally understood to<br />
imply the acquisition of shares carrying voting rights in a<br />
company in a direct or indirect manner with a view to gaining<br />
control over the management of the company. It also<br />
implies that the acquirer is much larger than the acquired.<br />
Where the acquired firm is larger than the acquirer, the<br />
acquisition is referred to as a `reverse takeover`.<br />
Mergers and Amalgamations:<br />
<strong>The</strong> terms mergers and amalgamations have not been defined<br />
in the Companies Act, 1956. Amalgamation has been<br />
defined in Section 2(1B) of the Income Tax Act 1961, as<br />
merger of one or more companies to form one company,<br />
the company or companies merging are referred to as the<br />
amalgamating company or the companies and the company<br />
with which they merge to or which is formed as a result of<br />
the merger is known as the amalgamated company. <strong>The</strong><br />
amalgamated company also referred to as the acquiring<br />
company or merged company acquires the assets and liabilities<br />
of the amalgamating company, also referred to as the<br />
acquired company, merging company or Target Company.<br />
<strong>The</strong> shareholders of the amalgamating company get shares<br />
of the amalgamated company in exchange for their shares<br />
in the amalgamating company.<br />
Sections 391 and 394 of the Companies Act 1956 constitute<br />
a legislative tool that facilitates merger and amalgamation<br />
of companies, both public and private, whether listed<br />
48 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
or unlisted. Section 391 is a complete code and once a<br />
Scheme of Amalgamation is sanctioned by the High Court<br />
, it encompasses the approval under other provisions of the<br />
Act – for example reduction of Share Capital. Two or more<br />
companies can amalgamate only when the amalgamation<br />
is permitted under their Memorandum of Association. In<br />
case either of the companies is listed, compliance of listing<br />
agreement is obligatory. Further, the individual companies<br />
should hold separate meetings of their shareholders and<br />
creditors for approving the amalgamation scheme. Atleast,<br />
75 percent of shareholders and creditors in separate meeting,<br />
voting in person or by proxy, must accord their approval<br />
to the scheme. Where the shareholders and creditors have<br />
given their no objections to such merger, the meetings<br />
of shareholders and creditors may be exempted provided<br />
their number is around 50. Both the concerned companies<br />
shall normally file two separate petitions, one each by<br />
the transferor and transferee before the High Court where<br />
the registered office of the company is situated. However,<br />
Delhi High Court in the case of Mohan Exports (India)<br />
Ltd v. Tarun Overseas Pvt. Ltd [1999] 95 Comp Cas 53<br />
has held that a joint petition may also be<br />
made by both parties. <strong>The</strong> High Court,<br />
after it is satisfied that the scheme is fair<br />
and reasonable, may pass an order, sanctioning<br />
the amalgamation scheme. After<br />
the Court order, its certified true copies<br />
will be filed with the Registrar of Companies.<br />
<strong>The</strong> assets and liabilities of the<br />
acquired company will be transferred to<br />
the acquiring company in accordance with<br />
the scheme approved by the High Court.<br />
Takeover or gaining control:<br />
Takeover or gaining control over a company, as opposed<br />
to pure investment, is the most common leitmotif for substantial<br />
acquisition of shares. Acquisition of voting shares<br />
in a closely held company being a domestic concern is<br />
regulated under Section 372A of the Companies Act 1956.<br />
Takeover or gaining control of a listed company generally<br />
takes place through a process of friendly negotiations or<br />
in a hostile manner in which, the existing management<br />
resists the change in control. It is for this reason that substantial<br />
acquisition of shares in and change in control a<br />
listed company take place within the orderly framework<br />
of regulations and that such a framework should be one<br />
which comports with principles of fairness, transparency<br />
and equity, and above all with the need to protect the rights<br />
of the shareholders.<br />
<strong>The</strong> first attempts at regulating takeovers were made in a<br />
limited way by incorporating a clause, viz. Clause 40, in the<br />
Listing Agreement which provided for making a public offer<br />
Two or more<br />
companies can<br />
amalgamate<br />
only when the<br />
amalgamation is<br />
permitted under<br />
their MoA<br />
to the shareholders of a company by any person who sought<br />
to acquire 25% or more of the voting rights of the company.<br />
This allowed for the passive participation of shareholders<br />
of the company that is being taken over, in the takeover<br />
process. One of several other deficiencies in the clause was<br />
being a part of the listing agreement, it could be made<br />
binding only on listed companies and could not be effectively<br />
enforced against an acquirer unless the acquirer itself<br />
was a listed company. At the recommendation of Bhawati<br />
Committee, SEBI (Substantial Acquisition of Shares and<br />
Takeover) Regulations 1997 [SEBI Takeover Regulations]<br />
was enacted as the regulatory framework where affected<br />
company is a listed company. <strong>The</strong> guiding principles of<br />
the regulations may be summarized as under:-<br />
i. <strong>The</strong> process of substantial acquisition of shares and takeovers<br />
is complex. Equality of treatment and opportunity<br />
to all shareholders.<br />
ii. Protection of interests of shareholders.<br />
iii. Fair and truthful disclosure of all material information<br />
by the acquirer in all public announcements and offer<br />
documents.<br />
iv. No information to be furnished by<br />
the acquirer and other parties to an offer<br />
exclusively to any one group of shareholders.<br />
v. Availability of sufficient time to shareholders<br />
for making informed decisions.<br />
vi. An offer is to be announced only after<br />
most careful and responsible consideration.<br />
vii. <strong>The</strong> acquirer and all other intermediaries<br />
professionally involved in the offer, to exercise<br />
highest standards of care and accuracy in preparing offer<br />
documents.<br />
viii. Recognition by all persons connected with the process<br />
of substantial acquisition of shares that there are bound<br />
to be limitations on their freedom of action and on the<br />
manner in which the pursuit of their interests can be<br />
carried out during the offer period.<br />
ix. All parties to an offer to refrain from creating a false<br />
market in securities of the target company.<br />
x. No action to be taken by the target company to frustrate<br />
an offer without the approval of the shareholders.<br />
Takeover as per SEBI (Substantial and Takeover) Regulations<br />
1997 [SEBI Takeover Regulations] means when an<br />
Acquirer takes over the `shares` or `control` of the Target<br />
Company- a listed company. Based on `Bright Line tests`,<br />
other persons having commonality of objectives and a community<br />
of interests along with the Acquirer in the proposed<br />
acquisition of voting shares beyond the threshold limit, are<br />
considered as Persons Acting in Concert (PAC) and their<br />
shareholding is thus grouped together with the Acquirer.<br />
July-October - 2007 Need the Dough<br />
49
IN FOCUS<br />
Control includes right to appoint majority of directors or<br />
to control the management or policy decisions, directly or<br />
indirectly of Target Company. Control may also be exercised<br />
by virtue of shareholding or management rights or<br />
shareholders agreements or voting agreements or in any<br />
other manner.<br />
Any Acquirer may acquire voting shares upto 5% in any<br />
financial year of a listed Target Company. <strong>The</strong> Acquirer may<br />
consolidate his holding upto 15% shares or voting rights in<br />
the listed target company. SEBI Takeover Regulations is<br />
triggered when Acquirer acquires or purposes to acquire any<br />
further voting shares, he shall have to acquire a minimum<br />
20% shares by making an open offer to other shareholders of<br />
that target company - Public Announcement of his intention<br />
to such acquisition. <strong>The</strong> price for acquisition is arrived at by<br />
way of price discovery mechanism. Further, irrespective<br />
of whether or not there has been any acquisition of shares<br />
or voting rights in a company, no acquirer shall acquire<br />
control over the target company, unless such person makes<br />
a Public Announcement to acquire shares and acquires such<br />
shares in accordance with SEBI Takeover Regulations. To<br />
regulate such acquisitions, the Takeover Code prescribes<br />
event-based initial and continual disclosures by Promoters,<br />
PAC and othe shareholders holding specified voting shares<br />
in a listed company. Further, very often acquisition of shares<br />
or voting rights may become necessary in commercial and<br />
business interests and certain cases of transfer of shares<br />
among two set of persons may not result in a takeover and<br />
the interest of shareholders may not be jeopardized. In such<br />
cases, Merit-based exemption from the requirement of making<br />
mandatory public offer may be granted by SEBI at the<br />
recommendation of Takeover Panel. Furthermore, where<br />
a shareholder passively crosses the threshold limit he has<br />
been exempted from making the public offer; nonetheless,<br />
he has to disclosure his holdings.<br />
M&A and the Competition Policy:<br />
Developing countries do need a competition policy in the<br />
wake of the international merger movement as well as because<br />
of privatization, deregulation and liberalization, which<br />
have occurred in their domestic economies and consequential<br />
impact on their domestic M&A. While examining this<br />
issue, a distinction was found between developing countries<br />
and developed countries. In order to give effect to the stated<br />
desire in the Singapore WTO Ministerial Declaration of<br />
December 1996, “to ensure that the development dimension<br />
is fully taken into account”, it would not be enough to simply<br />
suggest that all that developing countries need is a longer<br />
time frame to be able to implement the US or UK type of<br />
competition policy. <strong>The</strong> special and different circumstances<br />
of the developing countries and their development needs<br />
require a creative application and understanding of the competition<br />
policy formulations. Accordingly, they should be<br />
given a free hand in formulating their competition policy.<br />
In India, the MRTP Act 1969 (now repealed) and the<br />
Consumer Protection Act 1986 (CPA) deal with the anticompetitive<br />
practices. However, the MRTP Act was limited<br />
in its scope and hence it failed to fulfi ll the need of a<br />
competition law in an age of growing LPG. A High-Level<br />
Committee on Competition Policy and Law was set up in<br />
October 1999 under the Chairmanship of SVS Raghavan<br />
to examine the then existing MRTP Act for shifting the<br />
focus of the law from curbing monopolies to promoting<br />
competition and to suggest a modern competition law in line<br />
with international developments to suit Indian conditions.<br />
<strong>The</strong> Committee submitted its report in May 2000 which<br />
has been enacted in October 2003. <strong>The</strong> Committee felt<br />
that the Competition law should cover both types of M&A<br />
– horizontal and vertical, if it is established that they prejudice<br />
competition. <strong>The</strong> agreements that contribute to the<br />
improvement of production and distribution and promote<br />
technical and economic progress, while allowing consumers<br />
a fair share of the benefits, should be dealt with leniently.<br />
On the contrary, certain anti-competitive practices such as<br />
blatant price, quantity bid and territory sharing agreements<br />
and cartels should be presumed to be illegal.<br />
<strong>The</strong> Competition Act, 2002 failed to curb prevailing anticompetitive<br />
practices in India, after having been notified as<br />
law in October 2003. Litigation over the appointments of<br />
Chairperson and Members of the Competition Commission<br />
before the High Court of Madras and the Supreme Court of<br />
India (Brahm Dutt vs. Union of India and others in the Writ<br />
Petition No. 490 of 2003) respectively, kept the development<br />
of Indian competition law in limbo. <strong>The</strong> Government<br />
was unable to notify substantive provisions of the law. An<br />
Amendment Bill has been moved by the Government and<br />
is expected to be passed soon. To capture the intent and<br />
spirit of Competition Commission the observations of Prof.<br />
Alan Fels, former Chairman of the Australian Competition<br />
and Consumer Commission (ACCC) during his recent visit<br />
to New Delhi are noteworthy “competition advocacy and<br />
public awareness campaigns on competition issues are better<br />
achieved through orders of a Commission”.<br />
Cross border M&A in India:<br />
Grant Thornton Survey Report 2006 on M&A in India<br />
concludes that over 70% of acquisitions have been done by<br />
India Inc. by cross border acquisitions. Liberalized economic<br />
and trade policies coupled with easy financing from<br />
PEs, outbound deals have surpassed the inbound deals over<br />
the last decades. Acquisitions of new skills and access to<br />
wider <strong>global</strong> market have catapulted India Inc.<br />
<strong>The</strong> Companies Act 1956 also provides for cross border<br />
M&A where a foreign body corporate, including a foreign<br />
50 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
company, could merge with an Indian company. Either a<br />
foreign company or a branch of a foreign company in India<br />
can merge with an Indian company by following the procedure<br />
provided for in section 391 to 394 of the Companies<br />
Act 1956 with the sanction of the High Court. Conversely,<br />
as the land stands today, when an Indian company merges<br />
with a foreign company, because the High Courts (of India)<br />
cannot go beyond the horizon of land, it appears due to<br />
lack of jurisdiction, such merger cannot be approved by the<br />
Indian High Courts. This inadequacy in Indian law have<br />
been judicially noticed by Andhra Pradesh High Court in<br />
the matter of Moschip Semi Conductor Technology Ltd<br />
[2004] 120 Comp Cas 108 (AP). Irani Committee Report<br />
has recommended for removal of this operational hurdle.<br />
Such mergers would reap in economic wealth to our domestic<br />
browses by listing of Indian Depository Receipts.<br />
Indian Shareholders of the foreign company would also<br />
enjoy the benefits of the foreign company. Our FDI may<br />
also see a trajectory growth.<br />
As cross border M&A involve movement of domestic<br />
currency overseas, recently liberalized Foreign Exchange<br />
Management (Transfer or Issue of any Foreign Security)<br />
Regulations, 2000 and Foreign Exchange Management<br />
(Transfer or Issue of Security by a Person Resident Outside<br />
India) Regulations, 2000 are also required to be complied<br />
with.<br />
Conclusion:<br />
<strong>The</strong> scale and the pace at which M&A activities are coming<br />
up in Indian Inc. are remarkable. <strong>The</strong> recent booms in<br />
M&A suggest that the organizations are spending a significant<br />
amount of time and money either searching for firms<br />
to acquire or worrying about whether some other firm will<br />
acquire them. Also, mergers are regarded as one of the fast<br />
track growth strategy or a measure of external growth in<br />
contrast to internal growths. <strong>The</strong> recent booms in M&A<br />
would increase at a much faster rate in near future because<br />
the world markets are becoming more integrated besides<br />
<strong>global</strong> push for open trade policies and easy and cheaper<br />
availability of funds especially Private Equity – Venture and<br />
Hedge funds. Because M&A have a universal impact, practically<br />
everyone from society, shareholders, employees, and<br />
directors to financial institutions, it should be so designed<br />
to create value or economic wealth for all the stakeholders<br />
of the corporate. Our laws also need to be aligned to this<br />
<strong>global</strong> economic integration phenomenon.
RESEARCH<br />
MERGERS AND ACQUISITIONS IN EMERGING<br />
ECONOMIES:<br />
A STUDY OF IMPACT ON SCALE ECONOMIES,<br />
TECHNOLOGICAL CHANGE AND STRUCTURAL<br />
SHIFT IN PROFITABILITY<br />
52 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
<br />
<br />
<br />
Introduction:<br />
Corporate entities are viewed as vehicles of value maximization<br />
for investors. Yet, they are also means of achieving<br />
diverse goals of different stakeholders. Viewed from this<br />
perspective, the objectives of mergers and acquisitions<br />
have been examined and studied as tools of achieving a<br />
number of different yet related objectives. Baumol (1967)<br />
and Mueller (1969) found merger and acquisition activity<br />
as a means of empire building. Shleifer and Vishny (1989)<br />
observed it to be a means of management entrenchment.<br />
Likewise mergers have been resorted to for enhancing<br />
monopoly power (Mueller, 1993); to improve the performance<br />
of an entity/target perceived to be underperforming<br />
(Roll, 1986). However, from the stand point<br />
of a world view that resources are limited and only the<br />
fittest can survive, the appropriate paradigm explaining<br />
merger and acquisition activity will be Efficiency <strong>The</strong>ory<br />
of Firms. <strong>The</strong> theory states that only efficient firms will<br />
survive and inefficient firms will be taken over (Manne,<br />
1965; Mead, 1968; Jensen, 1988).<strong>The</strong> issue has assumed<br />
great significance in emerging economies in view of rising<br />
trend in them towards M & A.<br />
<strong>The</strong>oretical and empirical research on motivations<br />
for mergers and acquisitions has identified a number of<br />
factors such as reduction in costs (Coase, 1937), elimination<br />
of hold up problems (Williamson, 1979), mitigation<br />
of uncertainties in market transactions (Klein,<br />
Crawford and Alchian, 1979), risk aversion (Blair and<br />
Kaserman, 1978) and meeting the challenges posed<br />
by price inflexibility (Carlton, 1979) and competition<br />
(Perry, 1989). <strong>The</strong>se factors collectively constitute the<br />
effort to overcome internal management hurdles and to<br />
improve the efficiency. Studies on managerial performance<br />
have revealed that often poor performance is the<br />
consequence of managers deviating their focus from<br />
long term value maximization and profitability (Rappaport,2002<br />
). Deflection of the focus leads to decline<br />
in the operating efficiency leading to poor performance<br />
and non realization of the potential. Poor performance<br />
in the presence of good resources and potential attracts<br />
buyers/investors who believe that operating efficiency<br />
and value can be increased if methods and techniques<br />
of utilization of resources are improved. <strong>The</strong> acquiring<br />
firms are propelled to buy the target with the objective of<br />
transforming the operational landscape and practices to<br />
bring about improved efficiency, by Mr. Jangoo input-output Dalalratios and<br />
hence value. Another most Sr. VP-Enterprise, commonly cited Cisco managerial Systems (India & SAARC)<br />
motivation for undertaking M&A is unlocking synergies<br />
(Walter and Barney, 1990). Unlocking synergies means<br />
creation of economic gains when assets are used more<br />
effectively by the combined entity than by the target<br />
and acquirer separately (Shelton, 1988). This occurs pri-<br />
July-October - 2007 Need the Dough<br />
53
RESEARCH<br />
marily due to efficient utilization and rearrangement of<br />
resources (Jarrell, Brickley and Netter, 1988). <strong>The</strong> logic<br />
is to achieve higher efficiency gains by combining two<br />
entities that will contribute and complement each other’s<br />
performance. Buyers will recognize specific complementarities<br />
between their firm and the target. Although both<br />
firms are performing well but the two are believed to<br />
do even better when the two are combined, whatever<br />
maybe the motivation the mergers must result in efficiency<br />
and economies. Empirical research investigating<br />
the efficiency of M&A has failed to provide unequivocal<br />
results. In one of the most comprehensive and classical<br />
study (Ravenscraft and Scherer, 1987a, 1987b), employing<br />
comprehensive and narrowly disaggregated accounting<br />
data it examined the mergers in the US in the sixties. It<br />
concluded that these mergers were essentially failures,<br />
more recent studies (Scherer, 1999, 2002) provide mixed<br />
evidence. <strong>The</strong>se studies show that some mergers yield<br />
significant efficiencies while others fail because either<br />
they bid too much or because of corporate<br />
culture mismatches, incentive<br />
failures or clumsy implementation.<br />
Likewise, Mueller and Burkhard<br />
(1999) found little evidence of efficiency<br />
gains. <strong>The</strong>y attributed the<br />
inefficiency due to the lack of integration<br />
of organizations; similar<br />
results were reported by Bhuyan<br />
(2002). Likewise in a study one of<br />
hundred and sixteen mergers by<br />
Copeland, Kotler and Murrin (1990)<br />
it was that only 23% were successful<br />
while 61% registered negative results. Porter (1987) and<br />
Young (1981) also arrived at similar results. However,<br />
Lichtenberg and Siegel (1992) reported significantly improved<br />
labour productivity after the implementation of<br />
acquisition programs.<br />
McGuckin Nguyen (1995) found significant positive<br />
relationship between labour productivity growth and<br />
change of ownership. <strong>The</strong>y also concluded that buyer<br />
firms acquire poorly performing plants because they are<br />
good assets with substantial positive potential which can<br />
be utilized for enhancing values of the combined firm.<br />
Mixed results relating to impact on efficiency notwithstanding,<br />
a sharp rise in the M&A activity in both<br />
developed and emerging markets has lead to a plethora<br />
of research by academics as well as practitioners to find<br />
whether this activity is leading to justifiable economic<br />
gains by creating value for the owners or not. Research<br />
studies have mostly focused on finding the quantum of<br />
value generation or value destruction and how the gains<br />
and losses of M&A transactions are shared between the<br />
54 Need the Dough July-October - 2007<br />
In efficient markets,<br />
market value and stock<br />
registers changes<br />
around merger<br />
announcements to fully<br />
capture and reflect the<br />
economic gains from<br />
the merger<br />
targets and the acquirers. As stated above if the M&A<br />
activity have the capability to improve the efficiency<br />
through internal management change and unlocking<br />
of synergy, the activity must demonstrate evidence of<br />
significant value creation. Besides, an investigation in<br />
this issue is important for it may have significant policy<br />
implications for regulators. Needless to say, objective<br />
assessment of the results of these transactions is necessary<br />
to assess whether society’s resources are being put<br />
to efficient use or not.<br />
Event Studies:<br />
Majority research in the area of financial study of M&A<br />
has largely sought to address the issue of value creation<br />
and destruction for shareholders by employing the event<br />
study methodology initiated by Fama, Fisher, Jensen<br />
and Roll (1969). <strong>The</strong> event study methodology asserts,<br />
if combined stock prices rise in the few days surrounding<br />
merger announcements, it must be because rational stock<br />
market investors anticipate future<br />
earning gains. <strong>The</strong> theoretical foundation<br />
rests on the assertion that<br />
in efficient markets, market value<br />
and stock registers changes around<br />
merger announcements to fully capture<br />
and reflect the economic gains<br />
from the merger. Empirical studies<br />
also have more or less unanimously<br />
proven the theoretical assertion.<br />
Event studies have found increase<br />
in shareholder value of target firms<br />
as a manifest of significant positive<br />
cumulative abnormal return around merger announcement.<br />
Be that as it may the methodology is fraught with<br />
serious flaws. First, the findings showing positive shareholder<br />
value for target firms around merger announcement<br />
do not really mean much. Partly because this is<br />
exactly what one would expect to happen, for target<br />
shareholders they must receive a premium if they have<br />
to handover their stake to the acquiring firm. Moeller<br />
Schlingmann and Stulz (2004) report that between 1980<br />
and 2001 acquiring firms paid a mean premium of 68%<br />
for large firms and 62% for small firms. <strong>The</strong> offered<br />
premiums may in fact be overpayments (Roll, 1986).<br />
Secondly, event study conclusions rest strictly on the validity<br />
of the assumption that markets are efficient. <strong>The</strong>re<br />
is plenty of evidence to show that stock market value may<br />
temporarily deviate from the fundamental levels (Healy,<br />
Palepu and Ruback, 1992). Mitchell, Pulvino, and Stafford<br />
(2004) also indicate that announcement period of<br />
normal return is due to merger, arbitrage and short-sell-
MERGERS & ACQUISITIONS<br />
ing, rather than information. <strong>The</strong> study contradicts the<br />
premise that stock prices solely reflect value changes. It<br />
clearly questions the event study’s ability to distinguish<br />
the real economic gains from market inefficiency. Finally,<br />
value can be said to have been created if one can establish<br />
unequivocal evidence of creation of efficiency and its<br />
causes. Since event study approach cannot perform this<br />
task, there is need to examine how input output relations<br />
transform as a result of M&A activity. More so in case<br />
of emerging economies which are under<strong>going</strong> a process<br />
of fast transformation and which often are characterized<br />
by absence of efficient markets.<br />
<strong>The</strong> Present Study:<br />
Accordingly, the present study aims at examining the economic<br />
gains of M&A activities by investigating whether<br />
mergers result in economies of scale and technological<br />
change. Understanding these issues is critically important<br />
both to understand the economic rationale behind the<br />
corporate decision maker’s action and to gauge whether<br />
M&A activity really leads to improvement in internal<br />
management and creation of synergy. It is obvious that if<br />
operating efficiency improves it must lead to emergence<br />
of economies. Since M&A represent structural changes<br />
in the firm and invariably a change in the scale of operations,<br />
the impact of mergers from the point of view<br />
of change in the scale needs to be properly scrutinized.<br />
Secondly, technological performance is strictly related<br />
to commercial and economic success (Franko, 1989) and<br />
represents one of the most important long term effects<br />
of acquisition. Unfortunately such long term effects of<br />
M&A tend to be underestimated (King et al, 2004).<br />
<strong>The</strong> present study attempts to examine the issue of<br />
efficiency by providing a detailed study of cost and technological<br />
structure of merged firms on one hand and<br />
structural shift in the profitability of the operations on<br />
the other, based on a large panel data extending over one<br />
decade. <strong>The</strong> study will serve three major purposes:<br />
1. Fill the void in the literature by (a) examining structural<br />
shift in the profitability of merging firms and (2)<br />
by examining the economies of scale as manifestation of<br />
efficiency by studying the underlying characteristics of<br />
production process represented in the cost structure.<br />
2. <strong>The</strong> study evaluates whether there is any technological<br />
change post M&A. Such a change is likely to act as a<br />
powerful proxy for the existence of synergy.<br />
3. <strong>The</strong> study employs panel data across three emerging<br />
economies namely India, Brazil and Malaysia and makes<br />
an attempt to study the influence of changing <strong>global</strong><br />
environment brought about by progressive movement<br />
towards integration of distant economies of the world.<br />
Method:<br />
To investigate whether the time of merger or acquisition<br />
in the life history of a firm represents the point of<br />
structural shift the present study uses structural shift<br />
model. Following the parametric approach of studying<br />
the characteristics of production process from structured<br />
production functions which represent of the underlying<br />
technical relations between input and output the present<br />
study employs cost function to investigate whether scale<br />
of economies and technological change occur as a result<br />
of M & A ; latter being the indicator of improvement<br />
in internal management .<strong>The</strong> cost function is also used<br />
to examine other relevant properties of the production<br />
process.<br />
Structural Shift Model:<br />
If M&A is successful one expects, as stated above, improvement<br />
in performance. Following DU- Pont analysis,<br />
efficiency and leverage manifest in return on equity<br />
(ROE). A successful merger must therefore demonstrate<br />
a structural shift in profitability from the point of view<br />
of owners, after the merger. Whether structural break<br />
has taken place at the point of merger can be statistically<br />
measured by regressing time variable (causal variable)<br />
on ROE (dependent variable) time series. It is well<br />
established in econometric literature that to arrive at<br />
reliable results from a time series, it is necessary to study<br />
whether it is stationary. If a time series is stationary, its<br />
mean, variance and auto covariance (at various lags) remain<br />
the same no matter at what time we measure them<br />
(Cuthbertson, Hall and Taylor, 1995). Such a time series<br />
will have mean reversion process. <strong>The</strong> series will tend<br />
to revert to its mean and fluctuations around this mean<br />
July-October - 2007 Need the Dough<br />
55
RESEARCH<br />
will have broadly constant amplitude. A stationary time<br />
series is time reverting, with constant mean and standard<br />
deviation of the random variable over time and covariance<br />
between two periods depends only on the distance<br />
or gap between the two time periods and not the actual<br />
time at which the covariance is calculated.<br />
<strong>The</strong> distinction between stationary and non-stationary<br />
time series has crucial bearing on when the trend is<br />
deterministic or stochastic . <strong>The</strong><br />
classical suggestion that time series should be detrended<br />
works well for the deterministic series rendering its trend<br />
stationary. If the series is stochastic it is recommended<br />
that it should be differenced before being regressed on<br />
others. This process however may lead to substantial loss<br />
of long run information.<br />
Stationarity is popularly checked using Dickey-Fuller<br />
unit root test or Augmented Dickey-Fuller test (1979) or<br />
Phillips-Perron test (1988). One of the problems with<br />
unit root tests is that they cannot distinguish between<br />
the existence of a stochastic trend and a structural trend<br />
in a time series. That is, these tests ignore a shift in the<br />
intercept or trend midway in the time series. Presence<br />
of a structural break or shift implies that the data consist<br />
of two more data sets with trend levels of different<br />
intercepts caused by an exogenous variable such as shift<br />
in policy paradigm or a complete break from previous<br />
structural environment as happens in case of M&A activity.<br />
Presence of such structural shift leads to a bias<br />
in Augmented Dickey Fuller and Phillip-Perron tests.<br />
<strong>The</strong>se tests conclude that time series is non-stationary.<br />
This is possible even if the series is stationary within<br />
each of the sub-periods before and after the structural<br />
shift. A composite time series with a (or a finite number)<br />
structural shift shall display different characteristics from<br />
one with a stochastic trend. If the shift point is imposed<br />
on the data, as Perron does in his classic 1989 paper with<br />
the Great Depression as his reference point, it is easy<br />
to econometrically distinguish between the models of<br />
stochastic trends and models with structural shifts. However,<br />
if the shift points are random/ endogenous to the<br />
data and are imposed, the analysis is considerably more<br />
complex and the results are not so ‘robust’ (Christiano,<br />
1992 and Zivot and Andrews, 1992).<br />
<strong>The</strong> structural shifts occur due to technological change<br />
and innovations. <strong>The</strong> regression models incorporate<br />
these by using dummy variables. <strong>The</strong> dummy variable<br />
is given value zero in respect of observations before the<br />
structural change and one after the shift. Dummy variable<br />
can also be assigned by giving value of one only at<br />
the point of shift and zero otherwise. In the former case<br />
it is called “step” modeling of dummy variable and in the<br />
latter “pulse” modeling. <strong>The</strong> year of merger represents<br />
the time of structural shift in the life of the company. In<br />
the present study we have attempted to examine three<br />
models of structural shift. (Each one of these is an extension<br />
of Random Walk with Drift model.)<br />
Model 1: <strong>The</strong> Jump Model<br />
This model captures structural shift by permitting a<br />
one time shift in the trend. It allows for capturing the<br />
jump in the intercept and trend function. Its generalized<br />
form shall be<br />
(1)<br />
DUMt = 1 for time period after the merger and zero<br />
otherwise.<br />
Model 2: Growth Shift Model<br />
This model of structural change assumes a change<br />
in the slope of time-trend function without imposing<br />
any sudden change in the level at the point of structural<br />
shift. <strong>The</strong> model implicitly attempts to join two segments<br />
of trend function at the point of the shift. <strong>The</strong><br />
specification is:<br />
……….(2)<br />
where = (t – s) if t > s and zero otherwise ;and s =<br />
point of shift.<br />
Model 3: Shift in Intercept and Growth Model<br />
This model attempts to capture the change in the intercept<br />
as well as the slope of the trend function. It allows for<br />
a sudden change in the intercept that is a structural shift accompanied<br />
by a different growth path. <strong>The</strong> specification is:<br />
<strong>The</strong> estimation procedure involves three steps:<br />
First, the regression equations specified in the models<br />
given above are estimated and their residuals t is computed.<br />
Secondly, residual εt are regressed on 1 period<br />
lagged residual εt-1. We estimate the following equation:<br />
(4)<br />
<strong>The</strong> equation assumes absence of serial correlation<br />
among the residuals of equation (4). In case these residuals<br />
are infected with serial correlation augmented<br />
regression of the following type is used:<br />
(5)<br />
To test the presence of serial correlation we have employed<br />
Lagrange Multiplier (LM) test.<br />
In the third and last step we calculate the value of<br />
t- statistic for null hypothesis HO : a1 = 1 . For the<br />
purpose of statistical inference Perron has provided critical<br />
values at different levels of significance in respect of<br />
(3)<br />
56 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
capital and labour on the other is relatively small indicating<br />
some degree of complementarity. Table-6 provides<br />
the estimates of own and cross price elasticities.<br />
Table 7 summarises the estimates of own and cross<br />
price elasticities of conditional input demands. All price<br />
Table 5<br />
Test of Restrictions Using Pindyck’s Coefficient<br />
Degrees of<br />
Freedom<br />
Total<br />
Sample<br />
elasticities are negative, with all input demands except for<br />
profit being highly price elastic. <strong>The</strong> cross price elasticities<br />
contain much of the same information contained<br />
in the elasticities of substitution and indicate substitutability<br />
among all inputs. Increases in cost of materials<br />
induce increased profit but very slight response in labour<br />
and capital utilization. Profit use also responds relatively<br />
highly for increases in wages and capital costs. Increases<br />
in capital costs cause a modest increase in labour use.<br />
Overall, Tables 5 and 6 provide additional assurance that<br />
our representation of the technology is reasonable and<br />
methodology adopted in this study is appropriate.<br />
Economies of scale and technological innovations:<br />
Finally, let us examine the results relating to economies<br />
of scale as well as technological change as a result of M<br />
& A. Table 8 presents the results relating to returns to<br />
scale measuring responsiveness of cost due to change in<br />
output after merger holding input prices constant. <strong>The</strong>se<br />
estimates of scale elasticities are measured as per equation<br />
(12). In respect of the total sample it can be seen that the<br />
coefficient of scale elasticity is 1.29. <strong>The</strong> coefficient is<br />
India Brazil Malaysia Chi Sq<br />
at.001<br />
Homotheticity 4 2.15 4.12 3.11 9.23 18.47<br />
Homogeneity 5 3.11 6.35 6.44 11.23 20.52<br />
Cobb-Douglous 12 12.054 22.36 9.25 25.36 36.12<br />
Table 6<br />
Allen Elasticitiess<br />
Materials Labour Capital Profit<br />
Materials -0.36244<br />
(-3.09333)<br />
Labour 0.03251 -1.0354<br />
(-4.01214) (-6.98)<br />
Capital 0.05761 1.1423 -2.3959<br />
(-4.00946) (-15.32) (-4.702)<br />
Profit 1.0258 1.24.331 1.0549 -9.475<br />
(-4.823) (-11.104) (-7.25) (-14.24)<br />
Figures in parentheses are t values<br />
greater than 1. It implies that an equi-proportional rise<br />
in all the inputs is leading to more than proportional<br />
increase in output. Thus the sample data of the present<br />
study shows that M & A activity results in economies of<br />
scale. Table 8 also shows that coefficient of scale elasticity<br />
is greater than<br />
1 in respect of individual<br />
countries also.<br />
Thus the merged firms<br />
tend to operate on declining<br />
portion of the<br />
average cost function<br />
when costs are plotted<br />
against output. One<br />
can examine how scale<br />
economies change over a period of time. In the context of<br />
M & A, we are interested in knowing whether the output<br />
level at which minimum average cost can be achieved<br />
increases overtime. That is to say, we need to examine<br />
whether M & A activity leads to rise in the range of output<br />
over which average cost can be reduced further due<br />
to economies of scale. To investigate the occurrence of<br />
economies of scale over time, we can define economies<br />
Table 7<br />
Direct Elasticities<br />
Materials Labour Capital Profit<br />
Materials -0.2185 0.02746 0.0025 1.15725<br />
(-3.15) -3.26 -3.21 -5.68<br />
Lobour 0.0658 -0.45879 0.1958 0.3154<br />
(4.25) (-9.254) -5.26 -7.36<br />
Capital 4.69 0.3154 -0.5891 0.1654<br />
(12.825) (6.25) (8.256) (5.25)<br />
Profit 1.1153 0.5421 0.2014 -1.123<br />
(8.25) (7.256) (7.23) (14.25)<br />
Figures in parantheses are t values<br />
or diseconomies of scale in terms of cost elasticity. If<br />
cost elasticity is greater than 1, it implies existence of<br />
scale economies. If it is less than 1 it implies existence<br />
of diseconomies of scale.<br />
<strong>The</strong> first derivative of cost elasticity (defined as reciprocal<br />
of scale elasticity) with respect to time T (βC/βT) is<br />
given by βQt in equation 8. A βQt less than zero indicate<br />
that the percentage increase in cost due to 1% increase<br />
in output falls over time. This suggests an increase in<br />
the degree of scale economies over time. In other words<br />
a βQt less than zero will indicate that the output level<br />
at which the long run cost is at minimum has increased<br />
over time. That is the size of the firm at which all the<br />
July-October - 2007 Need the Dough<br />
61
RESEARCH<br />
economies of scale are exhausted has registered an increase.<br />
From Table 4, one can observe that in respect<br />
of all the firms taken together the<br />
coefficient of βQt is negative. It means that on an<br />
average, scale economies have increased over time in case<br />
of merged firms. That is the size of minimum efficient<br />
firm has increased. <strong>The</strong> finding shows that when firms<br />
merge, they are able to increase the range of output over<br />
which they can reduce their long run average cost. That is<br />
they can enjoy positive scale economies over an expanded<br />
output range. βQt is negative in case of Indian and<br />
Malaysian firms but is positive for Brazil. It means that<br />
in case of Brazilian mergers scale economies is declining<br />
over time and the range of output over which minimum<br />
long run average cost can be achieved is falling.<br />
Let us now examine the rate of technical change. <strong>The</strong><br />
coefficients of the rates of technological change are also<br />
presented in Table 8. <strong>The</strong> estimates are arrived at in<br />
accordance with equation (18). In respect of the total<br />
sample the rate of technical change is .00176. That is<br />
there is a decrease in total cost at a rate of 0.17% per<br />
annum. Similarly positive rates of technological change<br />
are observed in case of individual countries also. <strong>The</strong><br />
estimates clearly show that M & A result in technical<br />
change across countries. To gain further insight into<br />
the nature of technological change, input bias in it can<br />
be measured according to equation (19). <strong>The</strong> coefficients<br />
of input bias are presented in Table 8. It can be observed<br />
that the coefficients are negative in case of labour and<br />
capital of total sample which means there are factor saving<br />
technological advancements in respect of labour and<br />
62 Need the Dough July-October - 2007<br />
capital. <strong>The</strong> positive coefficient in respect of materials<br />
indicates that the technological advancement is material<br />
using. In case of Indian firms the technological advancement<br />
is labour and materials saving but capital using and<br />
in case of Brazil it is labour saving but materials and<br />
capital using. In Malaysia technological advancement<br />
is factor saving on account of labour, capital as well as<br />
materials.<br />
Lastly, we examine whether technological change increases<br />
scale economies or decreases these as per equation<br />
(20). It can be seen from Table 8 that the coefficient<br />
of technological scale bias is positive in case of overall<br />
sample as well as India and Malaysia. It is negative in<br />
case of Brazil. This implies that the technological change<br />
is increasing the economies of scale, that is the increase<br />
in output level at which long run average cost will be<br />
minimum, is expanding due to technological innovations.<br />
This finding indicates that merged firms are likely<br />
to introduce technological innovations.<br />
In conclusion, it can be stated that M & A activity leads<br />
to structural shift in the profitability after merger as well<br />
as economies of scale and technological innovations. <strong>The</strong><br />
economies are factor saving and increase the range of<br />
output over which the economies can be availed. Technological<br />
innovations also contribute to these economies.<br />
<strong>The</strong> study thus supports the hypotheses that mergers<br />
lead to both improvement in internal management and<br />
unlock synergy.<br />
<br />
References:<br />
● Baumol, W.J. (1967) Business Behavior, Value, and<br />
Table 8<br />
Resuls of Analysis of Scale Economies and Technological Change<br />
Growth. Harcourt, Brace, and World:<br />
New York, NY.<br />
● Bhuyan, Sanjib (2002) Impact Of Vertical<br />
Total Sample India Brazil Malaysia<br />
Mergers On Industry Profitability: An<br />
Coefficient<br />
1.29095 1.38558 1.09188 1.21024 Empirical Evaluation, Review of Industrial<br />
of Scale<br />
Elasticity<br />
Organization (20),61-79.<br />
● Blair, R.D., Kaserman, D.L.(1978) Vertical<br />
Integration, Tying, And Antitrust<br />
Coefficient 0.00176 0.03219 0.00508 0.00669<br />
Policy, American Economic Review 68,<br />
of Rate of<br />
397-402.<br />
Technological Change<br />
● Carlton, D. W.(1979) Vertical Integration<br />
In Competitive Markets Under<br />
Input Bias<br />
in Technological<br />
Change<br />
Labour -0.00612 -0.03398 -0.00363 -0.00660<br />
Uncertainty,Journal of Industrial Economics<br />
27, 189-209.<br />
● Christiano, L.J. (1992) Searching for a<br />
Capital -0.01100 0.00152 0.01379 -0.00097 Break in GNP, Journal of Economic and<br />
Materials 0.04560 -0.00032 0.01366 -0.00535<br />
Business Studies,10, 237-250.<br />
● Coase, R.H.(1937) <strong>The</strong> Nature Of <strong>The</strong><br />
Technological<br />
Scale Bias ( -βQt ) -(-0.07590) -(-0.00194) 0.01032 -(-0.01387)<br />
Firm, Economica 4, 386-405.<br />
● Copeland, Tom, Kotler, Tim & Jack<br />
Murrin. (1990) Valuation, Measuring And
MERGERS & ACQUISITIONS<br />
<strong>The</strong> Value Of Companies. New York, Wiley.<br />
● Cuthbertson Keith, Hall ,Steven G., and Mark P.<br />
Taylor. (1995) Applied Econometric Techniques, <strong>The</strong><br />
University of Michigan Press. p.130.<br />
● Dickey D.A. and W.A. Fuller .(1979) Distribution of<br />
the Estimators for Autoregressive Time Series with a<br />
Unit Root, Journal of the American Statistical Association,<br />
74, 427-431. See also W.A. Fuller, Introduction to<br />
Statistical Time Series, John Wiley & Sons, New York,<br />
1976.<br />
● Fama, E.F., L. Fisher, M.C. Jensen, and R. Roll. (1969)<br />
<strong>The</strong> adjustment of Stock Prices to New Information,<br />
International Economic Review 10, 1-21.<br />
● Franko, L.G. (1989) Global Corporate Competition:<br />
Who’s Winning, Who’s Losing And <strong>The</strong> R&D Factor<br />
As One Reason Why, Strategic Management Journal,<br />
10: 449-474.<br />
● Healy, M.H., K.G. Palepu and R.S. Ruback. (1992)<br />
Does Corporate Performance Improve After Mergers<br />
Journal of Financial Economics, 31, 135-175.<br />
● Jarrell, G.A., J. Brickley and J. Netter.(1988) <strong>The</strong> Market<br />
For Corporate Control: <strong>The</strong> Empirical Evidence Since<br />
1980, Journal of Economic Perspectives, 2, 49-68.<br />
● Jensen, M.C. (1988) <strong>The</strong> Takeover Controversy: Analysis<br />
and Evidence,” Knights,Raiders, and Targets: <strong>The</strong> Impact<br />
of Hostile Takeover. J.C. Coffee, Jr., L.Lowenstein,<br />
and S. Rose-Ackerman (Eds.), Oxford University Press:<br />
Oxford, UK.<br />
● King, D., Dalton, D., Daily, C., and J. Covin. (2004)<br />
Meta-Analyses Of Post-Acquisition Performance: Indication<br />
Of Unidentified Moderators, Strategic Management<br />
Journal, 25:187-200.<br />
● Klein, B., Crawford, R. A., Alchian, A. A.(1978) Vertical<br />
Integration, Appropriable Rents, And <strong>The</strong> Competitive<br />
Contracting Process, Journal of Law and Economics<br />
21, 297-326.<br />
● Lichtenberg, F., and D. Siegel. (1992) Productivity<br />
and Changes in Ownership of Manufacturing Plants,<br />
Corporate Takeovers and Productivity. F.R. Lichtenberg<br />
(Ed.), <strong>The</strong> MIT Press: Cambridge, MA.<br />
● Manne, H.G. (1965) Mergers and the Market for Corporate<br />
Control. Journal of Political Economy 73,110-<br />
120.<br />
● McGuckin, R.H., and S.V. Nguyen.(1995) On Labor<br />
Productivity and Plant Ownership Change: New Evidence<br />
from the LRD. <strong>The</strong> Rand Journal of Economics<br />
(26:2) , 257-276.<br />
● Meade, J.E. (1968) Is the New Industrial State Inevitable<br />
Economic Journal 78,372-392, June.<br />
● Mitchell, M., T. Pulvino and E. Stafford.( 2004) Price<br />
Pressure Around Mergers, Journal of Finance 58.<br />
● Moeller, S.B., F.P. Schlingemann and R.M. Stulz.(2004)<br />
Wealth Destruction on a Massive Scale A Study of Acquiring-Firm<br />
Returns in the Recent Merger Wave, Journal<br />
of Finance 58, 146-159.<br />
● Mueller, D.C. (1969) A <strong>The</strong>ory of Conglomerate Mergers,<br />
Quarterly Journal of Economics 83,643-659.<br />
Mueller, D.C. (1993 ). Mergers: <strong>The</strong>ory and Evidence,In<br />
Mergers, Markets and<br />
● Public Policy. Giuliano Mussati (Ed.), Kluwer: Dordrecht,<br />
the Netherlands,<br />
● Mueller, D.C. and Raunig Burkhard (1999) Heterogeneities<br />
Within Industries And Structure-Performance<br />
Models, Review of Industrial Organization 15,<br />
303-320.<br />
● Perry, M.K.(1989) Vertical Integration: Determinants<br />
And Effects, In R. Schmalensee and R.D. Willig Eds.,<br />
Handbook of Industrial Organization, Volume I. Netherlands,<br />
Amsterdam: Elsevier Science Publishers B. V.<br />
Phillips P.C.B. and P. Perron. (1988) Testing for a Unit<br />
Root in Time Series Regression, Biometrica 75, 335-346.<br />
<strong>The</strong> PP test is now included in several software packages.<br />
● Pindyck, Robert S. (1976) International Comparisons<br />
Of <strong>The</strong> Residential Demand For energy: a preliminary<br />
analysis, Working Paper, Massachusetts Institute of Technology,<br />
#MIT EL 76-023WP.<br />
● Porter, M.E. (1987) From Competitive Advantage To<br />
Competitive Strategy, Harvard Business Review, 65(3).<br />
Rappaport, Alfred.(2002) Creating Shareholder Value: A<br />
Guide for Managers and Investors,Free Press.E-book.<br />
Ravenscraft, D.S. and Scherer, F.M. (1987a) Profitability<br />
of Mergers, International Journal of Industrial Organizations,<br />
17.<br />
● Ravenscraft, D.J., and F. M. Scherer. (1987b) Mergers,<br />
Selloffs, and Economic Efficiency ,(Brookings Institution).<br />
● Roll, R. (1986) <strong>The</strong> Hubris Hypothesis Of Corporate<br />
Takeovers, Journal of Business 59, 197-216.<br />
● Scherer, F. M. (1980) Industrial Market Structure and<br />
Economic Performance (2nd edition: Rand-McNally).<br />
Scherer, F. M. (1999) New Perspectives on Economic<br />
Growth and Technological Innovation (Brookings Institution).<br />
● Scherer, F. M. (2002) <strong>The</strong> Merger Puzzle, in W. Franz<br />
et al., eds, Fusionen (Tuebingen: Mohr Siebeck), 1-22.<br />
● Shelton, L.M. (1988) Strategic Business Fit And Corporate<br />
Acquisitions, Strategic Management Journal 9,<br />
279-287.<br />
● Young, J.B. (1981) “A conclusive investigation into<br />
causation elements of failure in acquisition and merger”<br />
in S.J. Lee & R.D. Colman (eds.): Handbook of Merger,<br />
Acquisitions and Buyouts. Englewood Cliffes, New Jersey,<br />
Prentice Hall.<br />
July-October - 2007 Need the Dough<br />
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MERGERS & ACQUISITIONS<br />
different s , where is defined as<br />
where S = point of shift<br />
T = total no. of observations<br />
If the estimated statistic is greater than critical value,<br />
one can conclude that there is structural shift in the data.<br />
To make the analysis complete, we analysed the pre and<br />
post merger time series using the data of the target firms<br />
as well as the acquiring firm. Thus two sets of time series<br />
were constructed; one used target firm’s data of the premerger<br />
period and the other used acquiring firm’s data<br />
of the pre-merger period<br />
<strong>The</strong> Cost Function:<br />
To examine the underlying characteristics of production<br />
process<br />
we employ a twice differentiable four input production<br />
function of the following type<br />
Q = f (L, K, M, P) (6)<br />
Where Q is output and L, K, M, P represent inputs<br />
of labor, capital, materials and profit, respectively. We<br />
follow the “intermediation approach” in which materials<br />
combined with labor; capital and profit are assumed to<br />
be utilized to produce final output.<br />
We assume profit and / or value maximizing firms<br />
pursue cost minimizing behavior. <strong>The</strong>refore cost function<br />
can be uniquely represented by a dual cost function<br />
of the following form:<br />
C = f(Q,Zi,t) , for i = L,K,M and P (7)<br />
where, C is the total cost (including interest costs), Zi<br />
= input prices for i = L,K,M and P, and t represents time<br />
also it acts as a dummy for technological change.<br />
It is now well established in economic literature that as<br />
part of cost function time variable indicates technology.<br />
<strong>The</strong> time coefficient in the cost function has another<br />
interpretation also–a significant time -coefficient shows<br />
presence of technological change keeping all other variables<br />
constant. <strong>The</strong> time variable, being the residual one,<br />
captures the influence of other variables not incorporated<br />
explicitly in the cost function, including the impact of<br />
technology. For the purposes of specifying the explicit<br />
form of the cost function stated in equation (2) we use the<br />
standard translog specification. <strong>The</strong> reason for employing<br />
a translog function is that it provides a flexible functional<br />
form where it does not restrict the second-order properties<br />
of the cost structure examined. <strong>The</strong> translog form<br />
used for estimation is the following second-order Taylor<br />
series expansion of the cost function defined in eq. (2)<br />
(8)<br />
Employing Shephard’s Lemma one can arrive at the<br />
cost share of inputs. Accordingly dlnC/dlnzi represents<br />
the cost share of each input i. Hence, based on the cost<br />
function given in (3) we have the following share equations,<br />
one for each input i:<br />
Imposing the usual restrictions to reflect homogeneity<br />
of degree one in input prices namely,<br />
<strong>The</strong>se restrictions imply dropping the share equation<br />
of one of the inputs, using the associated input price<br />
as a numeraire. <strong>The</strong> input price of profit was used as a<br />
numeraire in the estimation.<br />
Above specifications lay down the statistical characterization<br />
of the production technology. However, before<br />
proceeding one must answer the questions whether the<br />
functional form adopted in the present investigation for<br />
representing technology is appropriate or not; secondly<br />
how to identify generalized/<strong>global</strong> characteristics of the<br />
underlying technology. Answers to these questions are<br />
necessary to avoid inappropriate inference due to the<br />
econometric misrepresentation of the technology. To this<br />
end, the present study makes an attempt to test whether<br />
the production process as captured by the above stated<br />
flexible functional form exhibits presence of homotheticity,<br />
homogenity and constant returns to scale. Also<br />
an attempt is made to compare it with a more restrictive<br />
Cobb-Douglas specification to find whether trans-log<br />
functional form is consistent with it or not. Estimates<br />
of elasticity of substitution among the stated cost inputs<br />
are also reported. Analysis of these aspects is likely<br />
to establish the preliminary confidence on data as well<br />
as the estimation procedure. With a view to evaluating<br />
the generalized characteristics of the technology as incorporated<br />
in the above stated cost functions standard<br />
comparison of restricted cost models is made with the<br />
unrestricted trans-log version.<br />
Presence of homotheticity in technology implies satisfying<br />
the following restriction :<br />
βQQ = βQt = 0; (10)<br />
Likewise a homogeneous production function (homogeneous<br />
with respect to output) must satisfy the following<br />
condition in addition to (5) above<br />
βiQ = 0. (11)<br />
Further a technology that exhibits constant returns<br />
to scale requires an additional restriction (in addition<br />
to (5) and (6)) that<br />
(9)<br />
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RESEARCH<br />
βQ = 0. (12)<br />
Finally, a Cobb-Douglas specification implies, in addition<br />
to (5), (6) and (7), the following restriction:<br />
βij = βiQ = 0. (13)<br />
Pindyck (1976) states that we can test restrictions using<br />
a simple chi-square test <strong>The</strong> appropriate test statistic<br />
is :<br />
-2 log C = n (log Ω* r - log Ω* u) (14)<br />
where, IΩ*rI and IΩ*uI are the determinants of the<br />
estimated error covariance<br />
matrices for the restricted and unrestricted models respectively.<br />
This statistic is distributed as chi-square with<br />
degrees of freedom equal to the number of parameter<br />
restrictions being tested.<br />
To characterize the nature of the production process<br />
further as represented by the cost functions, the study<br />
also estimates the Allen elasticities of substitution and<br />
elasticities of conditional input demands. From the cost<br />
and share equations, the measures of the Allen elasticities<br />
of substitutions are defined as:<br />
σij = βij/Si*Sj - 1/Si + 1 , for i = j, (15a)<br />
Where Si = cost share of input i<br />
σij = βij/Si*Sj + 1 for i ≠ j (15 b)<br />
<strong>The</strong> related own- and cross-partial elasticities of conditional<br />
input demand are given by:<br />
εij = βij/Si + Si - 1 , for i = j, and (16 a)<br />
εij = βij/Si + Sj , for i ≠ j. (16 b)<br />
Estimation of Economies of Scale:<br />
Economies of scale are said to exist if an increase in<br />
output, holding input prices constant, leads to a less than<br />
proportional increase in total costs, causing a decline<br />
in average costs. When two firms merge the size of the<br />
firm rises proportionally. If internal management of the<br />
combined firms improves and\or the synergies unlock,<br />
these will manifest in scale of economies in the same<br />
way as defined here. From the translog cost function<br />
stated in equation (3) above, returns to scale measuring<br />
cost responses resulting from changes in output, post<br />
merger holding input prices constant, can be derived<br />
as follows:<br />
firm result in a more than proportional increase in output.<br />
Evidence of scale economies, other things constant,<br />
could be a rationale for M & A activity.<br />
Investigation of synergy and technological Change<br />
It is well known fact in economics that a change in<br />
output holding the quantity and cost of inputs constant<br />
can occur if there is a change in technology. This concept<br />
has been employed in the present study in the context of<br />
evaluation of M&A. unlocking of synergies and improvement<br />
in internal management practices will be manifest<br />
in the significant technology coefficient of the cost function<br />
specified in the equation (3) above. Specifically, from<br />
the cost side, holding input prices constant, technological<br />
change permits the firm to produce the same level of<br />
output at lower expenditure. Given the cost function in<br />
(3), the rate of technological change can be measured<br />
by:<br />
Where<br />
= rate of technological change<br />
(18)<br />
Technological change can be biased with respect to inputs<br />
as well as with respect to the scale characteristics of<br />
the production technology. With regard to input biases,<br />
a technological change is Hicks-neutral, if the slope of<br />
the production isoquants is independent of technological<br />
change. A cost-neutral technological change, an analogous<br />
(but not equivalent) concept, refers to a technical<br />
change that does not affect relative cost shares of inputs.<br />
From the share equation in (4), a measure of input bias<br />
in technological change is:<br />
(19)<br />
A η = 0 imply a neutral technical change. η> 0 and<br />
η < 0 imply ith factor-using and ith factor-saving technological<br />
advancements respectively.<br />
Technological change could also be biased with respect<br />
to the scale property of the production technology.<br />
Technological change may be scale-biased or non-neutral<br />
in the sense that it might alter the range of outputs over<br />
which a given scale economies can be attained, thus resulting<br />
in a change in the cost-minimizing efficient firm<br />
size. Define the cost elasticity to be C=1/S, S=elasticity<br />
of scale. Technological scale bias is given by:<br />
(17)<br />
An estimate of S > 1 implies scale economies, indicating<br />
that an equiproportional increase in all inputs of a<br />
(20)<br />
A TSB > 0, implies that technological change increases<br />
scale economies and, conversely,<br />
58 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
If TSB< 0, scale economies are decreasing as a result of<br />
technological progress. A scale increasing technological<br />
progress (TSB > 0) implies that the minimum efficient<br />
size (MES) at which the average cost is the lowest is<br />
increasing due to technological innovations.<br />
Thus, the above analysis can provide insight into the<br />
future industry trends of M&A activities in the sense that<br />
a scale-increasing technological change, ceteris paribus,<br />
could induce further mergers in the industry over time.<br />
In contrast, a scale-decreasing technical change could<br />
lead to industry fragmentation or demerger activity.<br />
DATA<br />
<strong>The</strong> data were collected from the financial statements<br />
of the companies. <strong>The</strong>se data were obtained from the<br />
Thomson Analytics Database as well as Prowess Database.<br />
Apart from this, data were also obtained from the<br />
annual reports of the companies which were procured<br />
personally. Only those companies were selected which<br />
had indulged in M&A activity in the year 2000 in Brazil,<br />
Malaysia and India. Care was taken for selecting those<br />
companies which had a continuous data series available<br />
from 1990 to 2006. Different series were constructed on<br />
production, number of employees, fixed assets, materials<br />
and net profits after tax. <strong>The</strong>se respectively represented<br />
output, labour, capital, materials and profits as the primary<br />
inputs. Profit represented entrepreneurship. <strong>The</strong><br />
prices of these inputs were calculated as under:<br />
Price of labour was calculated by dividing wages and<br />
salaries and welfare expenditures by number of employees.<br />
Total materials were divided by the number of units<br />
produced to obtain the price of<br />
material per unit. Price of entrepreneurial<br />
factor input was calculated<br />
by arriving at ROE.<br />
In all there were 79 firms. Of<br />
these 34 were firms from Brazil,<br />
27 from Malaysia and the rest from<br />
India. <strong>The</strong> data were converted<br />
into US $ if not already available.<br />
This exercise had to be carried out<br />
in case of Indian companies whose<br />
data were not available in US $.<br />
Following the methodology of<br />
Thomson Analytics Database, the<br />
nominal effective exchange rate<br />
as reported in <strong>The</strong> Economic Survey<br />
of India for the particular year<br />
was used to convert local currency<br />
figures into US $. Similar exercise<br />
was carried out in case of Brazilian<br />
and Malaysian companies. In<br />
their case nominal effective exchange rates calculated by<br />
World Bank were used. <strong>The</strong> pooled cross-sectional time<br />
series data consists of 1343 data points.<br />
RESULTS AND ANALYSIS<br />
Structural Shift Model:<br />
<strong>The</strong> results of the exercise undertaken in respect of<br />
structural shift model are summarized in Tables 1, 2<br />
and 3. Table 1 shows that there is no serial correlation<br />
in any of the three structural shift models in respect of<br />
time series constructed with the data of target as well<br />
as acquiring firms. <strong>The</strong>refore augmented equation for<br />
regressing the residuals was not used. Secondly, Table<br />
2 lists the t-statistic of the slope coefficient of equation<br />
4 fitted in respect of the residuals of various models.<br />
<strong>The</strong>se t- statistics show that the coefficients are significant.<br />
Thus, the results clearly establish that there is a<br />
structural shift in the ROE after the merger whether<br />
we use data of target firm or that of acquiring company.<br />
Hence, M & A activity brings about an improvement in<br />
internal management as well as release of synergy. When<br />
this exercise is carried out in respect of the companies<br />
of individual countries the results are not different. It<br />
means M & A activity leads to a significant shift in the<br />
profitability of firms in emerging economies.<br />
Cost Function Model:<br />
<strong>The</strong> cost function in equation (8) and three of the associated<br />
four cost share equations are estimated simultaneously<br />
using Zellner’s Iterative Seemingly Unrelated<br />
Regression Estimates (SURE) technique. <strong>The</strong> estimates<br />
Table 1<br />
Test Statistics of Legrange-Multiplier for the Test of Ho: No serial correlation<br />
Jump Model Growth Shift<br />
Model<br />
July-October - 2007 Need the Dough<br />
Intercept and<br />
Growth Model<br />
Estimated Value<br />
1.98 .38 2.13<br />
Acquirer Series<br />
P-value .23 .81 .17<br />
Estimated Value (nR2)<br />
2.01 1.64 1.33<br />
Target Series<br />
P-Value .19 .41 .84<br />
Table 2<br />
Perron’s Test of Structural Shift in the ROE of Merged firms<br />
Estimated-t<br />
(Acquirer Series)<br />
Estimated t<br />
(Target Series)<br />
Perron’s critical<br />
value<br />
Jump Model 1.15 3.05 -3.48<br />
Growth and Shift Model 0.15 0.987 -3.48<br />
Intercept and Growth Model 1.14 0.847 -3.48<br />
59
RESEARCH<br />
Tabel 3<br />
Test of Structural Shift in the ROE of Merged firms in<br />
Emerging Economies<br />
Series Country Jump Growth and<br />
Shift Model<br />
Acquirer<br />
Series<br />
Target<br />
Series<br />
therefore are asymptotically equivalent to maximum likelihood<br />
estimators.<br />
<strong>The</strong> regression coefficient of equation 8, their standard<br />
errors and t-statistics are presented in Table-4. All coefficients<br />
except one are statistically significant at the one<br />
percent level of significance. This is true for both the<br />
Results of Translog Cost Function of Merged Firms<br />
Coefficient Standard<br />
Error<br />
Coefficients<br />
for India†<br />
60 Need the Dough July-October - 2007<br />
Intercept and<br />
Growth Model<br />
India 1. 501 0.05 0.48<br />
Brazil 0.89 0.12 0.11<br />
Malaysia 0.95 0.125 0.23<br />
India 0.15 0.087 0.37<br />
Brazil 0.853 0.22 .12<br />
Malaysia 1.03 0.31 .23<br />
Coefficients<br />
for Brazil†<br />
total sample as well as individual countries.<br />
<strong>The</strong> results relating to the test of homotheticity<br />
expressed in restriction stated in equation<br />
(10) are presented in Table 5. <strong>The</strong> test<br />
of restrictions imposed on cost function as<br />
well as share functions support the hypothesis<br />
of homotheticity. <strong>The</strong> cost function of<br />
the sample firms therefore is separable between<br />
output and input prices. This shows<br />
that cost, output and input price relationships<br />
can possibly be characterized <strong>global</strong>ly. <strong>The</strong><br />
strong acceptance of homotheticity implies<br />
strong support of homogeneity also. It can<br />
be observed from Table 4 that the direct test<br />
of homogeneity also accepts the homogeneity<br />
hypothesis. It is obvious that Cobb-Douglas<br />
specification as well as <strong>global</strong> constant returns to scale<br />
is also strongly supported.<br />
This implies that the assumptions underlying the restrictive<br />
cost functions and hence production structures<br />
offer a valid representation of technology of the merged<br />
sample companies. <strong>The</strong> production technology over the<br />
sample period is consistent with homothetic<br />
production process. <strong>The</strong><br />
Coefficients<br />
for Malaysia†<br />
Intercept 1.6949 0.573617 2.3123 1.8956 0.0198<br />
ln Z (L) 0.4422 0.008483 0.5823 0.4184 0.0089<br />
ln Z (K) 0.1023 0.000360 0.8790 0.0271 0.0022<br />
ln Z (M) -0.4558 -0.000177 0.6631 -0.0074 0.0069<br />
ln Z (LL) 0.7191 0.009455 0.0388 0.0033 0.0257<br />
ln Z (LK) 0.0761 0.001223 0.6819 0.0040 0.0195<br />
ln Z (LM) 0.1524 0.002126 0.0004 0.0134 0.0306*<br />
ln Z (LQ) 0.0044 0.000120 0.0008 0.0094 0.0016<br />
ln Z (LT) -0.0061 0.000933 -0.0340 -0.0036 -0.0066<br />
ln Z (KK) -0.0031 -0.000554 0.0183 0.0020* 0.0169<br />
ln Z (KM) 0.0015 1.489630 0.00061* 0.0064 -0.0085<br />
ln Z (KQ) 0.0586 -0.000647 0.0807 -0.0020 0.0163<br />
ln Z (KT) -0.0110 0.000672 0.0015 -0.0138 -0.0010<br />
ln Z (MM) -0.0865 -0.000154 -0.0042 -0.0216 0.0036<br />
ln Z (MQ) 0.0023 0.000059 0.0015 -0.0173 0.0013<br />
ln Z (MT) 0.0456 0.000817 -0.0003 0.0137 -0.0053<br />
ln(Q) 0.7053 0.002343 0.6336 0.9018 0.8001<br />
ln(QQ) 0.0799 0.007583 0.0070 0.0136 0.0208<br />
ln(QT) -0.0759 0.000630 -0.0019 0.0103 -0.0139<br />
ln(TT) 0.0443 0.000306 0.0005 -0.0049 0.0010<br />
ln(T) 0.0014 0.000317 0.0020 -0.0068 0.0191<br />
† All coeficients are significant except for those marked with *<br />
finding provides justification for the<br />
use of both a flexible functional form<br />
(adopted in the present study ) such<br />
as translog cost functions as well as<br />
restrictive production functions to<br />
capture the underlying production<br />
process.<br />
To understand the nature of production<br />
process of the merged firms<br />
more elaborately, estimates of the<br />
Allen elasticities of substitution were<br />
computed in respect of the firms in<br />
the sample. <strong>The</strong> results are presented<br />
in Table-6. <strong>The</strong> estimates show that<br />
all inputs are substitutes. Profit is<br />
a strong substitute for each of the<br />
other factors. <strong>The</strong>re is a strong substitutability<br />
between materials and<br />
profits perhaps because if material<br />
cost goes down profits are likely to<br />
increase. <strong>The</strong> results also show presence<br />
of strong substitutability between<br />
physical inputs namely labour<br />
and capital. It is explained probably<br />
by the tendency of merged firms<br />
to economise on labour costs. <strong>The</strong><br />
degree of substitution between materials<br />
and profits on one hand and
RESEARCH<br />
‘Strategic Objectives behind<br />
Corporate Acquisitions &<br />
the Impact of <strong>The</strong>se Acquisitions<br />
on Shareholders Wealth’<br />
Researchers believe that the firm’s ability to achieve a sustainable competitive<br />
advantage depends upon its relative cost and differentiation positions...<br />
64 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
<strong>The</strong> Main Idea behind any merger or an acquisition<br />
is: “One plus one makes three”, this equation<br />
is the special alchemy of a merger or an<br />
acquisition. <strong>The</strong> key principle behind buying a company<br />
is to create shareholder value over and above that of the<br />
sum of the two companies. Two companies together are<br />
more valuable than two separate companies - at least,<br />
that’s the reasoning behind M&A.<br />
This rationale is particularly alluring to companies<br />
when times are tough. Strong companies will act to buy<br />
other companies to create a more competitive, cost-efficient<br />
company. <strong>The</strong> companies will come together hoping<br />
to gain a greater market share or to achieve greater<br />
efficiency. Because of these potential benefits, target<br />
companies will often agree to be purchased when they<br />
know they cannot survive alone.<br />
World Wide Scenario:<br />
USA has seen 20 years long wave<br />
of mergers, leveraged buyouts<br />
and takeovers that changed USA,<br />
Inc. Biggest merger of the world,<br />
the $190 billion America Onlinemedia<br />
giant Time Warner (stock<br />
fi nanced deal) became second biggest in one month’s<br />
time. Previous biggest merger was MCI-world. Europe<br />
and Japan also have seen many mergers.<br />
<strong>The</strong> value of mergers in the <strong>global</strong> technology sector<br />
alone surged a 52 percent to $ 1.2 trillion in 1999 as<br />
companies scrambled to adapt their businesses to meet<br />
the growing demands of the internet economy. <strong>The</strong> total<br />
number of merger and acquisition transactions in the<br />
IT, media and communications sector rose <strong>global</strong>ly,<br />
according to a report by New-York based investment<br />
bank Broadview International.<br />
Indian Scenario:<br />
In India we have witnessed a storm of mergers and acquisitions<br />
in recent years. <strong>The</strong> Finance Act, 1999 clarified<br />
many issues relating to Business Reorganizations<br />
thereby facilitating and making business restructuring<br />
tax neutral.<br />
Compelled by the present economic scenario and<br />
market trends, corporate restructuring through mergers,<br />
amalgamations, takeovers and acquisitions have<br />
emerged as the best form of survival and growth for<br />
the companies all over the world.<br />
In the last few years, India has followed the worldwide<br />
trends in consolidation amongst companies<br />
through mergers and acquisitions. Companies are being<br />
taken over, units are being hived off,joint ventures<br />
tantamount to acquisitions are being made and so on.<br />
<strong>The</strong> <strong>global</strong> M&A was<br />
at a boom with an<br />
average of $ 12.5<br />
Billion worth of M&A<br />
per day<br />
It may be reasonably stated that the quantum of mergers<br />
and acquisitions in the last few years must be more<br />
than the corresponding quantum in the four and a half<br />
decades post independence.<br />
As per Finance Minister this has been done to accelerate<br />
internal liberalization and to release productive<br />
energies and creativity of Indian businesses. <strong>The</strong> year<br />
1999-00 has notched-up deals of over Rs. 21000 cr.<br />
which is over 1% of India’s GDP. This level of activity<br />
was never seen in the Indian corporate sector.<br />
InfoTech, banking, media, pharma, cement, power<br />
are sectors which are more active in mergers and acquisitions.<br />
Examples: ACC Gujarat- Ambuja Cement, Lafarge<br />
TISCO, Satyam Infoway-Indiaworld, Rajpal E capital-<br />
Zee tele-Subir Bhatia-HLL- lakme,<br />
HLL Tomco, Sandoz-Ciba,HLL-<br />
Lipton,IndiaCements-Rassi,<br />
Sun-TDPL,Sun-MJ, Wockhardt<br />
demerger, only distribution network-<br />
parents’ acquisitions- PAL<br />
– Peugot, Piramal Sarabhai, Piramal-<br />
Crossland, HDFC-Times<br />
Bank and many more. Among<br />
hostile takeover bids we saw Sterlite’s bid for Indal,<br />
Bajoria for Bombay Dyeing and Ballarpur Industries,<br />
Dalmia for Gesco and many more.<br />
Present Scenario as Per 2006:<br />
<strong>The</strong> average Indian M&A deal size was close to US<br />
$ 42 mn. <strong>The</strong> <strong>global</strong> M&A is also at a boom with an<br />
average of $ 12.5 Billion worth of M&A per day. Recently<br />
in one day $ 75 Billion worth of transactions took<br />
place including the largest private equity deal which<br />
was Blackstone’s $ 36 Billion offer for Equity Office<br />
Properties.<br />
<strong>The</strong> year 2006 has seen significant growth in acquisitions,<br />
as well as investments by India Inc. Key<br />
highlights of the year include:<br />
- <strong>The</strong> total number of deals at 782 compared to about<br />
467 in 2005. Of these there were 480 M&A deals and<br />
302 private equity ones.<br />
- <strong>The</strong> total value of deals at $ 28.2 billion compared<br />
to about $ 18.3 billion in 2005, recorded a growth of<br />
54%.<br />
- <strong>The</strong> average deal size (value per deal) being close to<br />
$ 36 million (including M&A and PE).<br />
- <strong>The</strong>re have been more than 40 deals with deal value<br />
of over $ 100 million.<br />
- 480 M&A deals with a total value of about $ 20.3<br />
billion in 2006 where the average deal size is of $ 42<br />
million.<br />
July-October - 2007 Need the Dough<br />
65
RESEARCH<br />
Sectoral Spread of M&A Deals:<br />
IT & ITES was the clear leader as far as sectoral values<br />
were concerned. This sector garnered US $ 2.9<br />
bn worth of deals. <strong>The</strong> major deals included EDS’s<br />
acquisition of majority stake in Mphasis BFL, RR Donnelley’s<br />
acquisition of Office Tiger, i-Flex’s acquisition<br />
of Mantas Inc etc.<br />
<strong>The</strong>re were 8 deals having value greater than US $<br />
500 mn. We haven’t included Tata-Corus deal in this<br />
edition. <strong>The</strong> clear leader in value with large deals were<br />
Dr. Reddy’s acquisition<br />
of Betapharm, Suzlon<br />
Energy’s acquisition of<br />
Hansen and Citigroup’s<br />
increasing stake in<br />
HDFC.<br />
<strong>The</strong> other sectors<br />
which have significantly<br />
contributed to the M&A value are telecom pharma &<br />
healthcare and energy.<br />
IT & ITeS leads the M&A volume proportion with<br />
20% share of total number of M&A deals. Pharma,<br />
Healthcare and Biotech have the second highest share<br />
at 10.4%. Other significant contributors to the deal volume<br />
are media & entertainment, banking & fi nancial<br />
services, FMCG, food & beverages. <strong>The</strong> key sectors<br />
contributing to M&A in 2006 are shown in the Table<br />
2. Traditionally it is thought that some large sectors<br />
like Commodities, IT, Pharma etc participate aggressively<br />
in M&A, but we are seeing every sector including<br />
retail, pharma stores, textiles, apparel, real estate,<br />
media, food, banking.<br />
Literature Review:<br />
A) Strategic objectives behind mergers and determinants<br />
for shareholder’s wealth<br />
By M. Mark Walker<br />
He investigated 454 acquisitions dated as per the<br />
Wall Street Journal to study the strategic objectives<br />
and stock price performance of acquiring fi rms. <strong>The</strong><br />
results support both the asymmetric information<br />
hypothesis (acquiring-fi rm shareholders earn higher<br />
returns following cash offers) and also the strategic<br />
66 Need the Dough July-October - 2007<br />
With deal worth of US<br />
$ 2.9 bn, IT & ITES was<br />
the clear leader as<br />
far as sectoral values<br />
were concerned<br />
alignment hypothesis (acquiring-fi rm shareholders<br />
earn higher returns following takeovers that either<br />
expand the fi rm’s operations geographically or increase<br />
its market share).<br />
B) Does Corporate Performance Improve After Mergers<br />
By Paul M. Healy, Krishna Palepu, Richard S.Ruback<br />
<strong>The</strong>y examined the post-acquisition operating performance<br />
of merged fi rms using a sample of the 50<br />
largest mergers between U.S. public<br />
industrial fi rms which happened during<br />
the period of 1979 to 1983. <strong>The</strong><br />
results indicate that merged fi rms<br />
have significant improvement in asset<br />
productivity relative to their industries<br />
after the merger, leading to<br />
higher post-merger operating cash<br />
flow returns. Sample fi rms maintain their capital expenditure<br />
and R & D rates relative to their industries<br />
after the merger, indicating that merged fi rms do not<br />
reduce their long-term investments. <strong>The</strong>re is a strong<br />
positive relation between post-merger increases in<br />
operating cash flows and abnormal stock returns at<br />
merger announcements, indicating that expectations<br />
of economic improvements underlie the equity revaluations<br />
of the merging fi rms.<br />
C) Can firms learn to acquire Do markets notice<br />
By Maurizio Zollo* and Dima Leshchinskii<br />
Using fi nancial, accounting and questionnaire response<br />
data they investigated the post acquisition<br />
performance of 47 US bank holding companies that<br />
executed 579 mergers and acquisitions in the 1964-<br />
1996 period.<br />
<strong>The</strong> objectives of the study were to identify the<br />
factors that explain the variance in the distribution<br />
of post-acquisition performance, and to test whether<br />
the fi nancial markets efficiently predict performance<br />
outcomes by incorporating public information about<br />
the acquiring fi rm into the stock price following the<br />
acquisition announcement.<br />
<strong>The</strong>y fi nd that prior acquisition experience does not<br />
improve post-acquisition performance, but the degree<br />
to which acquirers articulate and codify their experience<br />
in ad-hoc tools does. Financial markets do not<br />
seem to be sensitive to any of these predictors of performance<br />
in their short-term reactions, but long-term<br />
adjustments are significantly impacted by acquirers’<br />
integration strategies and codified implementation<br />
knowledge, in line with the variations of accounting<br />
returns.
MERGERS & ACQUISITIONS<br />
D) Multinational Enterprises and M&As in India: Patterns<br />
and Implications<br />
By Nagesh Kumar<br />
<strong>The</strong> paper makes an exploratory attempt to map out<br />
the recent M&A activity in the Indian corporate sector<br />
associated with foreign MNEs and their Indian affi liates.<br />
That is attempted with the help of an exclusive<br />
database built-up by us that cover<br />
most of the deals associated with<br />
MNEs in India for the period<br />
April 1993 – mid-February 2000.<br />
This database helps to examine<br />
the industrial composition of the<br />
deals as well as their motives.<br />
<strong>The</strong> research will include the<br />
study of the strategic objectives behind the takeovers,<br />
mergers, acquisitions from the Indian perspective and<br />
will also evaluate the stock price performance of the<br />
acquiring fi rm around the date of the announcement<br />
of the corporate takeovers.<br />
<strong>The</strong> research investigates the role that corporate<br />
strategies plays in explaining changes in acquiring-fi rm<br />
shareholder wealth at the takeover announcement date<br />
and conclude on the various aspects like:<br />
• <strong>The</strong> primary strategic objective behind the mergers,<br />
acquisitions or takeovers for acquiring-fi rm shareholders.<br />
• <strong>The</strong> mode of payment in the mergers and acquisition<br />
deals<br />
Relative cost and<br />
differentiation<br />
positions - mantras to<br />
achieve a competitive<br />
advantage<br />
Strategic objectives behind the corporate takeovers<br />
mergers and acquisitions:<br />
Researchers believe that the fi rm’s ability to achieve<br />
a sustainable competitive advantage depends upon its<br />
relative cost and differentiation positions. <strong>The</strong> relative<br />
cost and differentiation positions are determined<br />
largely by the fi rm’s horizontal and vertical boundaries.<br />
Horizontal boundaries focus on the varieties and<br />
quantity of goods or services the fi rm produces. Vertical<br />
boundaries defi ne the type of activities the fi rm<br />
products rather than it buys.<br />
<strong>The</strong> research has investigated the PRIMARY strategic<br />
objectives of each merger, acquisition by using the<br />
newspaper articles, any stock exchange announcements.<br />
<strong>The</strong> strategic objectives are considered according to<br />
the acquiring fi rm’s perspective.<br />
1 Capacity Expansion: Companies who wish to grow<br />
and increase their market share are indirectly looking<br />
for opportunities to increase their capacity. Example:<br />
2 Vertical Integration: When companies acquires its<br />
suppliers (backward) or buy out its immediate customers<br />
(forward) into its own business in order to<br />
have a good hold in its existing businesses.<br />
3 Geographic Expansions: when a company wants<br />
to establish its reach in some new geographic location,<br />
or in the new market segment then it targets<br />
a company who is well established in the desired<br />
area.<br />
4 Growth: when a company<br />
doing well in the business wishes<br />
to expand its business and invest<br />
more, it goes for growth strategy.<br />
5 Consolidation: When a<br />
group company acquires its subsidiary<br />
into itself. This strategy<br />
results into umbrella positioning in the market and<br />
produces synergy effect.<br />
6 Diversification: when a company wishes to start a<br />
new business other than the existing one, it goes<br />
for kind of strategy.<br />
7 Gaining Financial Strength: when a company acquires<br />
a cash rich company in order to utilize its<br />
cash position to expand, diversify, or increase capacity.<br />
8 Horizontal Integration: when a company acquires<br />
its competitors in the existing businesses.<br />
9 Broadening the Product Line: When the acquiring<br />
fi rm seeks economies of scope by expanding its<br />
product line.<br />
10 Increase In Market Share: this strategy is some what<br />
like the horizontal integration where in the acquiring<br />
fi rm buys its competitors.<br />
52 deals from 2001-2006:<br />
<strong>The</strong> primary strategic objectives behind the<br />
acquisitions from 2001-2006<br />
Strategic Objectives<br />
Frequency<br />
Capacity expansion 3<br />
Vertical integration 9<br />
Geographic expansion 2<br />
Growth 4<br />
Consolidation 18<br />
Diversification 4<br />
Gaining financial strength 1<br />
Horizontal integration 3<br />
Broadening product line 6<br />
Increase in market share 2<br />
TOTAL 52<br />
July-October - 2007 Need the Dough<br />
67
RESEARCH<br />
Mode of payment of the deals<br />
As in the acquiring firm, the acquired firm can decide<br />
upon an agreed swap ratio or can agree upon some<br />
amount of cash consideration. Example: <strong>The</strong> offer<br />
made to Ambuja cement eastern by Gujarat Ambuja<br />
cement was: Offer of four GACL equity shares of Rs<br />
2 each for every five ACEL equity shares of face value<br />
Rs 10 each.<br />
Mode of Payment<br />
<strong>The</strong> preferred mode of payment in the acquisitions<br />
from 2001-2006<br />
Conclusions:<br />
• Consolidation is the primary strategic objective<br />
behind the corporate acquisitions, followed by the<br />
vertical integration, diversification.<br />
• In total there are about 10 primary strategic objectives<br />
discussed in the research paper.<br />
• <strong>The</strong> majority of the deals were settled on the basis<br />
of Stock considerations.<br />
• In case the acquisition is of the merger type then<br />
the preferred mode of payment through stock (swap<br />
ratios) and in case the acquisition is of the type takeovers<br />
then the preferred mode of payment is cash.<br />
• <strong>The</strong>re are no significant changes seen in the abnormal<br />
returns around the date of the announcement<br />
of the corporate announcements.<br />
Limitations:<br />
• <strong>The</strong> time period considered in the research paper is<br />
from 2001-2006 only.<br />
• <strong>The</strong> acquiring companies considered in the data<br />
sample are actively trading on the stock exchanges<br />
in India.<br />
• <strong>The</strong> study revolves around the Indian economic<br />
changes<br />
• Cross- Border deals during 2001-2006 have been<br />
included.<br />
• <strong>The</strong> market adjusted approach in the only basis for<br />
the calculations for the abnormal returns.<br />
• A 5 trading day window was chosen for calculating<br />
returns.<br />
• In all the banking sector acquisitions or in the financial<br />
institutions takeovers, mergers have been<br />
excluded.<br />
• Only the primary strategic objectives have been considered<br />
and an assumption that these objectives are<br />
mutually exclusive has been made.<br />
<br />
Bibliography:<br />
1) www.envest<strong>india</strong>.com<br />
2) http://www.investopedia.com/university/mergers/<br />
3) <strong>The</strong> Bombay Stock Exchange (www.bse<strong>india</strong>.com)<br />
4) Christopher B. Kummer “Country-Specific Factors<br />
that Indian Companies are attracted by to Pursue<br />
Cross-border Mergers & Acquisitions (M&A)”<br />
5) <strong>The</strong> Economic Times<br />
6) <strong>The</strong> Hindu Business Line<br />
7) <strong>The</strong> Business Standard<br />
8) <strong>The</strong> Securities and Exchange Board of India (SEBI,<br />
www.sebi.gov.in)<br />
9) <strong>The</strong> Reserve Bank of India (RBI, www.rbi.org.in )<br />
68 Need the Dough July-October - 2007
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O UTREACH • OUTPERFORM • OUTSHINE
RESEARCH<br />
PRIVATE<br />
EQUITY RAIL<br />
BACKING<br />
M & A<br />
TRAIL<br />
By Mr. Ashwani Batra,<br />
Senior Analyst,<br />
Global Strategy & Investment<br />
Consulting, Planman<br />
Consulting (India) Pvt. Ltd.<br />
70 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
An abundance of private equity dollars, a favorable<br />
financing market, and strategic players<br />
wanting to expand geographic, demographic,<br />
and product reach are all contributing to a steady pace<br />
of M&A activity. As we consider the landscape for<br />
corporate transactions in mid-2007, the fundamentals<br />
are in line for a healthy merger and acquisition environment<br />
across all sectors. And although no blockbuster<br />
deals are percolating at present, the confluence of positive<br />
economic and market factors should prove fruitful<br />
for both buyers and sellers.<br />
Global M&A activity reached record highs as the volume<br />
of <strong>global</strong> deals in 2006 increased to over US$3.8<br />
trillion, representing a 37.9 per cent increase from 2005.<br />
This surpassed the previous record of $3.4 trillion set<br />
in 2000, with announced deals in the fourth quarter of<br />
2006 alone totaling approximately $1.3 trillion.<br />
Private equity transactions were some of the primary<br />
drivers of M&A activity: in 2006 they totaled $757.6<br />
billion worldwide, or approximately 20 per cent of total<br />
M&A activity. In 2006, 2,354 private equity transactions<br />
were announced, which represented a 172 per<br />
cent increase from 2005.<br />
One of the most notable features of LBO activity<br />
was the surge in deal size. Topping the charts was <strong>The</strong><br />
Blackstone Group’s $39 billion acquisition of Equity<br />
Office Properties Trust, which was the largest LBO in<br />
history at the time. Blackstone increased its original $36<br />
billion price to top a competing offer by a rival strategic<br />
buyer that emerged after Blackstone had entered into<br />
a definitive merger agreement with the target company.<br />
Other major private equity transactions in 2006<br />
included LBOs of HCA ($33 billion), Kinder Morgan<br />
($27.5 billion), Harrah’s Entertainment ($27.4 billion)<br />
and Clear Channel ($26.7 billion).<br />
In deals with US targets, private equity involvement<br />
climbed to record levels as more than $414.6 billion<br />
fi nancial sponsor transactions occurred in 2006 on the<br />
buyers’ and sellers’ sides, which represented just over<br />
a quarter of all US M&A activity. Private equity deals<br />
accounted for half of the top 10 M&A deals in the US<br />
and one quarter of the overall values.<br />
Europe accounted for 36 per cent of <strong>global</strong> private<br />
equity transactions by target region. <strong>The</strong> largest European<br />
LBO was the acquisition of VNU by AlpInvest,<br />
Blackstone, the Carlyle Group, Hellman & riedman,<br />
Kohlberg Kravis Roberts & Co (KKR) and Thomas H<br />
Lee Partners for $11 billion. Other leading European<br />
private equity transactions included LBOs of AWG<br />
($10 billion), Phillips Semiconductor ($9.5 billion),<br />
Kion ($5.7 billion) and PagesJaunes $4.2 billion).<br />
Mergers and acquisitions involving private equity<br />
funds in the Asia-Pacific region totaled $37.7 billion in<br />
2006, which represented a 7 per cent increase on 2005.<br />
North Asia deals amounted to $10.4 billion, led by<br />
Goldman Sachs’ $2.6 billion investment in Industrial &<br />
Commercial Bank of China, CVC Asia Pacific’s $2 billion<br />
bid for Australian radiology company DCA Group<br />
and the $1.5 billion offer for Taiwan’s China Network<br />
Systems by MBK Partners. India deals jumped to $3.1<br />
billion from $764 million in 2005, with the largest<br />
purchase being the acquisition of Electronics Software<br />
Systems by KKR. In the biggest Asia-Pacific private<br />
equity transaction of the year, announced in Decem-<br />
Worldwide Mergers & Acquisitions<br />
Overall M&A<br />
WW PE M&A<br />
Value Value % of<br />
($mil)| Deals ($mil)| Deals Total<br />
1995 925.2 19,688 28.0 584 3.0<br />
1996 1,116.7 23,853 33.8 612 3.0<br />
1997 1,640.0 25,898 52.5 758 3.2<br />
1998 2,493.1 29,376 59.0 942 2.4<br />
1999 3,265.4 32,183 107.4 1,327 3.3<br />
2000 3,400.0 38,716 97.3 1,795 2.9<br />
2001 1,687.0 30,174 63.9 1,315 3.8<br />
2002 1,208.6 26,482 106.4 1,196 8.8<br />
2003 1,360.9 28,830 128.8 1,561 9.5<br />
2004 1,865.3 31,543 237.7 2094 12.7<br />
2005 2,699.5 33,636 321.5 2700 11.9<br />
2006 3,600.7 37,839 750.0 3293 20.8<br />
2007* 2,179.3 14433 447.4 1238 20.5<br />
July-October - 2007 Need the Dough<br />
71
RESEARCH<br />
WORLDWIDE MERGERS & ACQUISITIONS<br />
YTD 2007 YTD 2006 Full Year 2006<br />
Macro Industry<br />
Value<br />
Deals<br />
Value<br />
Deals<br />
% Change<br />
Value<br />
Deals<br />
($bn)<br />
($bn)<br />
(YoY)<br />
($bn)<br />
Financials (Private Equity) 44.7 97 22.0 94 103.3 46.8 235<br />
Financials 474.1 1,686 166.1 1,532 185.5 568.7 4,360<br />
Private Equity % of Total 9.4 13.2 8.2<br />
Energy and Power (Private Equity) 53.4 53 5.0 48 974.6 53.9 152<br />
Energy and Power 304.1 1,060 171.5 996 77.3 527.1 2,738<br />
Private Equity % of Total 17.5 2.9 10.2<br />
Industrials (Private Equity) 39.0 209 48.3 206 -19.3 88.8 577<br />
Industrials 259.9 1,850 109.7 1,862 136.9 257.1 4,860<br />
Private Equity % of Total 15.0 44.0 34.5<br />
Materials (Private Equity) 16.8 99 7.4 107 126.9 31.5 299<br />
Materials 183.5 1,806 148.6 1,474 23.5 380.3 4,181<br />
Private Equity % of Total 9.2 5.0 8.3<br />
Real Estate (Private Equity) 24.5 40 17.4 38 40.8 95.2 101<br />
Real Estate 172.7 792 75.0 715 130.2 360.4 2,159<br />
Private Equity % of Total 14.2 23.2 26.4<br />
Consumer Staples (Private Equity) 36.2 102 3.6 84 905.0 12.7 227<br />
Consumer Staples 152.3 905 36.7 953 315.2 121.8 2,370<br />
Private Equity % of Total 23.8 9.8 10.5<br />
Healthcare (Private Equity) 45.0 83 12.2 76 268.8 77.1 208<br />
Healthcare 146.0 706 76.3 770 91.4 270.2 2,114<br />
Private Equity % of Total 30.8 16.0 28.5<br />
Media and Entertainment (Private Equity) 42.5 127 28.5 125 49.0 162.0 332<br />
Media and Entertainment 140.0 1,153 94.3 1,125 48.5 358.9 3,110<br />
Private Equity % of Total 30.4 30.3 45.1<br />
High Technology (Private Equity) 65.3 155 15.6 164 318.5 58.2 393<br />
High Technology 136.8 1,988 55.0 1,966 148.7 201.9 5,148<br />
Private Equity % of Total 47.7 28.4 28.8<br />
Telecommunications (Private Equity) 40.1 35 3.5 29 1,056.1 9.1 72<br />
Telecommunications 107.7 394 200.8 440 -46.4 300.7 1,054<br />
Private Equity % of Total 37.3 1.7 3.0<br />
Consumer Products (Private Equity) 21.4 149 7.5 166 185.8 41.8 459<br />
Consumer Products 53.8 1,401 32.7 1,435 64.5 105.6 3,861<br />
Private Equity % of Total 39.8 22.9 39.6<br />
Retail (Private Equity) 18.5 88 37.3 81 -50.4 72.8 236<br />
Retail 48.3 681 64.7 615 -25.4 147.1 1,842<br />
Private Equity % of Total 38.3 57.7 49.5<br />
Worldwide Industry Total (Private Equity) 447.4 1,238 208.2 1,218 114.8 750.0 3,293<br />
Worldwide Industry Total 2,179.3 14,433 1,231.6 13,900 77.0 3,600.7 37,839<br />
Private Equity % of Total 20.5 16.9 20.8<br />
72 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
ber 2006, Qantas Airways in Australia agreed to an<br />
$8.7 billion buyout by Texas Pacific Group (TPG) and<br />
Macquarie Bank.<br />
Private Equity growth supports M&A market, why<br />
Increased public profi le of private equity and continuation<br />
of club deals<br />
In light of the total amount of capital invested by<br />
private equity fi rms and record-breaking LBO sizes<br />
in 2006, the industry has fi rmly established itself as<br />
a major player in the <strong>global</strong> M&A market and private<br />
equity fi rms are among the most sought-after suitors for<br />
companies seeking to engage in a business combination<br />
transaction. According to Buyouts, 54 companies were<br />
successfully delisted from public exchanges in 2006,<br />
up from 38 in 2005 and 32 in 2004.<br />
This greater public profi le has resulted in some resistance<br />
to financial sponsor investments in certain<br />
jurisdictions. For example, notable opposition has been<br />
voiced by public investors, regulators and industry players<br />
in Germany, Korea and Australia. In response to the<br />
increasing number of private equity transactions, the<br />
UK’s Financial Services Authority undertook a study of<br />
the risks posed by such transactions and the potential<br />
need for increased regulation. <strong>The</strong> study concluded that<br />
private equity transactions posed no systemic risk and<br />
that private equity made a significant contribution to<br />
improving company competitiveness.<br />
invest in even larger transactions involving household<br />
name companies and to sustain high levels of private<br />
equity activity.<br />
<strong>The</strong>se types of high-profi le deals, together with sustained<br />
high levels of fi nancial sponsor activity, will<br />
contribute to increased public awareness of financial<br />
sponsors and the influence of private equity capital.<br />
It remains to be seen whether LBOs will constitute a<br />
similarly significant percentage of <strong>global</strong> M&A activity<br />
in 2007 as in 2006. Private equity firms will need to<br />
continue investing the large amounts of equity capital<br />
rose over the past several years and, ultimately, will<br />
begin to pursue various exit strategies from their portfolio<br />
investments, including initial public offerings,<br />
sales to strategic buyers or sales to other private equity<br />
firms. As a result, it is anticipated that private equity<br />
transactions will be important drivers of overall M&A<br />
activity and continue to have a significant impact on<br />
the <strong>global</strong> economy.<br />
Globalization is causing many boards to consider over-<br />
seas strategies:<br />
China, in particular, is seen as a huge potential source<br />
of revenue, especially for technology companies. Many<br />
companies now feel they need an emerging markets play<br />
and are keen to acquire the best businesses, regardless<br />
of where they are located. Synergies continue to be a<br />
driving force for deals.<br />
Diverse target industries:<br />
In the past year private equity transactions involved<br />
target companies in a wide range of industries. Traditionally,<br />
private equity firms have concentrated heavily<br />
in the manufacturing, distribution and services industries,<br />
each of which have historically generated target<br />
companies with steady cash flows. However, fi nancial<br />
sponsors are branching out into a variety of other industries,<br />
as their expertise, investment scope and available<br />
capital expand.<br />
Abundance of equity capital and debt financing:<br />
Private equity funds continued to set record fundraising<br />
levels in 2006. Private equity funds raised $406 billion<br />
last year, with 612 new funds launched, which exceeded<br />
the previous record of $311 billion set in 2005.<br />
Lenders have been provided more flexible debt structures<br />
to fi nancial sponsors to fi nance LBOs. <strong>The</strong> robust<br />
debt markets and abundance of equity capital were<br />
significant factors in the LBO surge in 2006, and it<br />
is likely that a continuation of favorable debt markets<br />
this year, combined with private equity’s significant<br />
cache of equity capital, will allow fi nancial sponsors to<br />
Particularly in the rapidly evolving TMT sector,<br />
where the markets for traditional providers and newer,<br />
Web-based technologies are converging, the idea that<br />
the best of both worlds can combine to create more<br />
productive and efficient entities is being more readily<br />
recognized.<br />
Buyout Boom Not Just for Biggest Firms:<br />
Buyout Boom Not Just for Biggest Firms:<br />
Private equity’s on<strong>going</strong> zeal for the middle market<br />
has many boards contemplating what they need to do<br />
to spark interest in their company. To no one’s sur-<br />
July-October - 2007 Need the Dough<br />
73
RESEARCH<br />
prise, the recent $20 billion and $40 billion LBO deals<br />
grabbed most of the M&A headlines in the fi rst quarter<br />
of 2007. But today’s capital markets offer abundant<br />
transactional opportunities for companies of all sizes,<br />
from private, middle-market fi rms to publicly traded<br />
large caps.<br />
And lower return requirements among an expanding<br />
pool of private capital means few industries are left<br />
out of the action any longer. Private equity fi rms and<br />
hedge funds have raised billions in new equity capital<br />
over the last few years, and they haven’t hesitated to<br />
put that money to work.<br />
Private Equity-<strong>The</strong> next biggest thing in the M&A mar-<br />
ket, how<br />
Private Equity M&A: <strong>The</strong> Force behind the Seller’s<br />
Market.<br />
<strong>The</strong>re are several reasons for the recent boom in<br />
private equity M&A activity. First, today’s market is<br />
over-flowing with private equity capital looking for<br />
investments. Many private equity funds took advantage<br />
of the strong market in 2005 and cashed out their<br />
investment portfolios, distributing loads of cash to<br />
their investors, many of which were pension funds.<br />
<strong>The</strong> pension funds used the profits realized in 2005<br />
and reinvested them last year in private equity investments,<br />
which are expected to continue generating rates<br />
of return well above what is available in the public<br />
markets.<br />
Furthermore, extraordinarily low spreads in the debt<br />
markets and the aggressive expansion of hedge funds<br />
into debt fi nancing offer plenty of cheap fi nancing.<br />
Also, the compliance costs and potential liabilities<br />
associated with Sarbanes- Oxley have driven many investors<br />
and managements from the public markets.<br />
Finally, private equity fi rms with six or seven year<br />
horizons that were created in the heyday of private<br />
equity investment in 1999 and 2000 are about to expire,<br />
leading their managers to dispose of numerous assets,<br />
which are increasingly being purchased by other private<br />
equity fi rms (in so called “secondary transactions”).<br />
All of these factors have led to a dramatic increase<br />
in the amount of capital in the private equity market<br />
and a substantial increase in the percentage of total<br />
M&A volume involving private equity buyers and sellers,<br />
which has swung the pendulum in the seller’s favor<br />
in today’s M&A market, where hungry buyers are on<br />
a buying spree.<br />
Private equity players are participating in larger and<br />
larger transactions, where traditionally private equity<br />
players had stayed mainly in the middle market. Seven<br />
of the ten largest buyouts of all time took place last<br />
year. In recent years, private equity players have been<br />
pooling their money to pay for large targets in socalled<br />
“club deals.” Furthermore, some fi nancial buyers<br />
are beginning to amalgamate such large portfolios of<br />
assets that they can take advantage of synergies that<br />
were once only available to strategic highly-capitalized<br />
buyers, in effect themselves becoming strategic buyers.<br />
<strong>The</strong>se trends have resulted in the entry of private equity<br />
funds into larger transactions, which means that sellers<br />
throughout the entire spectrum of transaction values<br />
are increasing their leverage ovessssr buyers. With so<br />
much excess cash on hand, private equity funds are<br />
competing in a race to deploy their funds. <strong>The</strong>re is<br />
an oversupply of money chasing a limited number of<br />
quality targets, causing private equity buyers who want<br />
to compete to offer sellers top prices and very seller<br />
friendly deal terms.<br />
With so much excess cash on<br />
hand, private equity funds are<br />
competing in a race to deploy<br />
their funds<br />
No Financing Contingency:<br />
Most leveraged buyouts in the United States traditionally<br />
have provided that one of the conditions to<br />
a buyer’s obligation to consummate the transaction is<br />
that the buyer has obtained the requisite fi nancing,<br />
as those transactions by defi nition involve significant<br />
leverage and sponsors do not maintain significant cash<br />
on hand from operations. However, recent private equity<br />
M&A transactions have been consummated with<br />
no fi nancing contingency, including the following<br />
major transactions: the $21.3 billion leveraged buyout<br />
of hospital operator HCA by a consortium of private<br />
equity funds including Bain Capital Partners, Kohlberg<br />
74 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
Kravis Roberts & Co. and Merrill Lynch Global Private<br />
Equity; the $8.3 billion acquisition of ARAMARK by<br />
Joseph Neubauer and investment funds managed by<br />
GS Capital Partners, CCMP Capital Advisors and J.P.<br />
Morgan Partners, Thomas H. Lee Partners and Warburg<br />
Pincus LLC; and Apollo Management, L.P.’s $9<br />
billion acquisition of Realogy Corporation.<br />
Reverse Break-Up Fees:<br />
Although break-up fees, imposing penalties on the seller<br />
in the event that the transaction is not consummated,<br />
are common in takeover deals involving two public<br />
companies, private equity buyers have traditionally<br />
resisted them. Recently, sellers have been demanding<br />
“reverse break-up fees,” to shift deal-completion risk to<br />
private equity buyers. For instance, under the terms of<br />
the $27 billion buyout of Clear Channel Communications,<br />
Inc., announced in November 2006, the private<br />
equity group buyer consortium, led by Bain Capital<br />
Partners, LLC and Thomas H. Lee Partners, L.P., will<br />
be required to pay a break-up fee in the amount of<br />
$500 million to Clear Channel if they cannot obtain<br />
fi n a n c i n g.<br />
Assumption of Industry Risk in MAC Conditions:<br />
It is becoming more common for private equity buyers<br />
to assume the risk of downturns in the seller’s industry<br />
as an exception to the “material adverse change” closing<br />
condition. Private equity buyers have historically<br />
objected to assuming industry risk on the basis that<br />
they do not become industry participants until they<br />
close the acquisition. However, in almost 80% of private<br />
equity deals announced in 2005 and early 2006,<br />
the buyer assumed industry risk in material adverse<br />
change closing conditions.<br />
Limited Indemnification:<br />
Sellers taking advantage of their market power and<br />
desiring to make a clean exit are insisting on limited<br />
indemnification provisions to minimize the magnitude<br />
of their exposure and the length of time during which<br />
the buyer can bring an indemnification claim. Indemnification<br />
basket amounts are increasing and liability caps<br />
are decreasing. Buyers are agreeing to shorter survival<br />
periods: where once buyers could expect survival periods<br />
of up to three years, many recent transactions have<br />
had survival periods of just one year or less.<br />
Private equity funds are also expected to continue<br />
to expand from investing in traditional industrial companies<br />
into other industries. <strong>The</strong> flow of capital to the<br />
private equity markets has been and will continue to<br />
be a powerful driving force behind the seller’s market.<br />
As greater competition and pricing pressure continue<br />
to mount, buyers who intend to remain competitive in<br />
the seller’s market will have to increase their purchase<br />
prices, limit their closing conditions and accept limited<br />
post-closing recourse.<br />
India – <strong>The</strong> offloading destination for Private Equi-<br />
ties:<br />
With India emerging as an economic powerhouse and<br />
domestic companies showing great appetite for mergers<br />
Industry experts say that the<br />
full potential of private equity<br />
investment in India has not<br />
been unleashed yet<br />
and acquisitions both domestically and <strong>global</strong>ly, India<br />
has become very much a part of their top priority list.<br />
India was ranked at twelfth position in the total M&A<br />
deal value and volume in CY06, whereas it has managed<br />
to climb to seventh position in the first three months<br />
of CY07. And private equity fi rms are eyeing this new<br />
found desire of India INC’s empire building plans to<br />
capitalize on.<br />
This development comes at a time when there is a<br />
growing need felt in India for an alternative avenue of<br />
fund raising for small and medium enterprises (SMEs).<br />
Many feel that private equity can act as an alternative<br />
source of raising fi nance and fi ll this gap to a great<br />
extent. With private equity investment, these firms will<br />
not only be able to get the much needed resources for<br />
their future expansion and growth but would also be<br />
able to leverage the expertise of these private equity to<br />
both drive operational performance and access <strong>global</strong><br />
markets. With the participation of private equity, the<br />
July-October - 2007 Need the Dough<br />
75
RESEARCH<br />
system of corporate governance, fi nancial reporting<br />
etc will dramatically reach <strong>global</strong> standards.<br />
Even industry experts say the full potential of private<br />
equity investment in India has not been unleashed yet.<br />
<strong>The</strong>re are certain hurdles, which are coming in the way<br />
of private equity investment in India. <strong>The</strong> most important<br />
one is the FDI cap prevailing in certain sectors<br />
such as telecom, aviation, banking, insurance, NBFCs<br />
etc which is limiting their scope of investment in India.<br />
Even if they make any investment in these sectors their<br />
exit becomes difficult due to these sectoral caps.<br />
<strong>The</strong> new guidelines issued by the government on<br />
overseas issue of preferential shares, though rightly intended<br />
to restrict the flow of money into the Indian real<br />
estate sector, have hit the overall private equity industry<br />
itself. <strong>The</strong> new guidelines have also put certain restrictions<br />
on the deal structuring capability of private equity<br />
players intending to invest across the sectors, admits a<br />
domestic private equity player who did not wish to be<br />
named. Another major issue confronting private equity<br />
investors is limited number of good companies available<br />
for investment because of lack of proper fi nancial<br />
information and other materials. This has resulted in<br />
large funds chasing few of them making it difficult to<br />
gain entry. This in turn is pushing up their valuations<br />
higher which often tend to affect their future returns.<br />
<strong>The</strong>n there are many mid-sized enterprises, which are<br />
largely family controlled and where the entrepreneurs<br />
are not willing to dilute control over the management.<br />
But most PE fi rms want a say in the management and<br />
functioning of the company.<br />
In spite of these challenges, the Indian PE market<br />
is booming and the industry is bullish on its growth<br />
prospects. Certain sectors which are looking good<br />
are pharma/biotech, real estate/construction, infrastructure,<br />
manufacturing, retail, IT and IT-related<br />
services.<br />
Recently, General Atlantic, Goldman Sachs and Saif<br />
Partners picked up stake of 5% each in the National<br />
Stock Exchange. Another private equity fund Chrys<br />
Capital has invested $24 mn in Mankind Pharma. In<br />
2006, the Carlyle group invested $20 mn in Claris Life<br />
sciences. Industry sources say private equity fi rms are<br />
active in Indian real estate and infrastructure sectors.<br />
<strong>The</strong>y invest in Special Purpose Vehicles (SPVs) set up<br />
by these companies and pick up stake in established<br />
real estate companies. In 2006, private equity investment<br />
rose by over 230% to $7.46 billion compared to<br />
$2.26 bn invested in 2005. <strong>The</strong> first quarter of 2007<br />
has already witnessed an investment of $2.5 billion<br />
from private equity fi rms up from $1.27 billion during<br />
the same period, according to data released by Venture<br />
Intelligence.<br />
Overall, there is a broader consensus among private<br />
equity players that India is a suitable destination offering<br />
great opportunities for the growth of private<br />
equity investment. It is only a matter of time, say experts,<br />
when the huge potential in this industry will<br />
be realized.<br />
Forecast M&A Activity by World Region:<br />
<strong>The</strong> analysis shows that, in the fi rst five months of<br />
2007, there was a significant discrepancy between the<br />
key trend indicators of deal values and volumes. <strong>The</strong><br />
last time the market witnessed this kind of disconnect<br />
where the average deal size rose, but the number of<br />
deals fell - occurred at the height of the dot com boom<br />
in 2000. A sign that the market is starting to cool came<br />
in H2 2006 when the total number of deals fell for the<br />
fi rst time since H1 2003 (dropping 8 percent compared<br />
to H1 2006).<br />
<strong>The</strong> analysis shows that the appetite for M&A transactions<br />
appears to be slowing, despite conservative<br />
balance sheets. Twelve month forward PE valuations<br />
<strong>The</strong> analysis says that Europe<br />
continues to exhibit the<br />
strongest M&A picture out of<br />
all the major <strong>global</strong> regions<br />
rose marginally to 17.1x compared to 16.8x in both<br />
June and December 2006 which implies a restriction on<br />
the available bid premium in the marketplace. Balance<br />
sheet capacity remains conservative but has tightened<br />
marginally from 0.85 times to 0.91 times.<br />
Of the major <strong>global</strong> regions, Europe remains the<br />
most positive in terms of potential M&A activity, due<br />
to rising PE momentum, while AsPac once again looks<br />
the weakest. <strong>The</strong> U.S. remains static in terms of valuation,<br />
suggesting the potential for a slow down.<br />
In terms of sector regions, the best M&A prospects<br />
appear to reside in Utilities Europe, Basic Materials<br />
North America, Oil and Gas North America, Industrials<br />
Europe and Consumer Services Europe with the<br />
weakest prospects being Consumer Services AsPac and<br />
Consumer Goods AsPac.<br />
Europe:<br />
<strong>The</strong> analysis shows that Europe continues to exhibit<br />
the strongest M&A picture out of all the major <strong>global</strong><br />
regions. Twelve month forward PEs stood at 16.2x<br />
at the end of the first five months of 2007, some 7.3<br />
76 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
percent above the 15.1x at the end of 2006. Net debt<br />
to EBITDA ratios for the region weakened slightly,<br />
from 0.8 times to 0.88 times.<br />
By sector, Utilities are eliciting the most significant<br />
“activity” signals, with forward PEs up 12.7 percent to<br />
19.8x. Net debt to EBITDA ratios in European Utilities<br />
remain typically among the highest of any sector<br />
and have deteriorated slightly from 1.44 x to 1.52 x.<br />
Industrials has also shown a strong tendency with PE’s<br />
up 10.9 percent to 17.7x, with net debt to EBITDA<br />
weakening slightly from 1.59 x to 1.65 x. Consumer<br />
Services and Telecoms were also strong (PE up 9.6<br />
percent and 8.4 percent respectively). Oil and Gas was<br />
the weakest performer though balance sheets remain<br />
very strong with net cash, though this position has<br />
deteriorated during the past six months.<br />
<strong>The</strong> European market remains largely buoyant. <strong>The</strong><br />
key difference between now and then, however, is the<br />
dramatic influence of private equity, which continues<br />
to hunt-down stable cash flow, attractive growth prospects<br />
and profitable companies. Private equity players<br />
are accounting for a greater volume of deals being done,<br />
but more importantly average private equity deal size<br />
is increasing, with the likes of Carlyle and Blackstone<br />
highly prominent in Europe. Of course the efficient<br />
debt market is supporting market buoyancy. Liquidity<br />
remains good, enabling highly-leveraged deals to be<br />
undertaken.<br />
U.S.A.<br />
<strong>The</strong> U.S. traded sideways in terms of valuation with<br />
an almost unchanged forward PE of 17.9x, slightly up<br />
from 17.7x six months ago. Similar to Europe, balance<br />
sheets remain robust though have deteriorated with<br />
net debt to EBITDA ratios of 0.82 times to 0.96 times.<br />
Within the region, the most positive sector is Oil and<br />
Gas with forward PEs rising 13.6 percent from 11.7x<br />
to 13.3x. Balance sheets remain strong at 0.41 times<br />
indicating that this represents the comparatively hot<br />
sector <strong>going</strong> forward. Telecom is close behind with<br />
forward PEs rising 11.2 percent from 15.7x to 17.5x,<br />
though net debt EBITDA ratios have deteriorated<br />
to 1.41 times. According to Dealogic data this is the<br />
fourth consecutive drop in deal volumes. Most other<br />
sectors within the U.S. remain relatively stable, though<br />
Healthcare has experienced negative developments in<br />
forward PEs from six months ago (down 4.1 percent<br />
to 17.7x).<br />
Liquidity in the market is still good so the ability to<br />
get deals fi nanced remains high, fuelling M&A activity<br />
in North America. A lot hinges on the recovery for<br />
North American Auto Original Equipment Manufacturers<br />
and the impact it could have on the significant<br />
parts suppliers throughout the continent. Consolidation<br />
in the auto parts industries is expected to pick up pace.<br />
Furthermore, competitive <strong>global</strong> pressure on North<br />
American manufacturers has put significant pressure<br />
on CEOs to reach for increased economies of scale and<br />
penetrate new markets, which should support M&A<br />
activity in the medium term.<br />
North of the border, there may be a more robust<br />
picture. A large part of Canada’s ever-popular income<br />
trust sector was halted last year by proposed changes to<br />
the Canadian Income Tax Act causing many of these<br />
mid-size public companies to evaluate their strategic<br />
options and participate in significant M&A activity.<br />
<strong>The</strong>re are 250 income trusts in Canada with a market<br />
capitalization of approximately US$200 billion. Energy<br />
and resource companies are still expected to remain<br />
strong as world commodity markets experience strong<br />
growth from growing <strong>global</strong> demand.<br />
Asia Pacific:<br />
Asia Pacific:<br />
Asia Pacific has continued to experience a valuation<br />
decline, down a further 4.9 percent to 17.0x, compared<br />
to 17.9x as at the end of December 2006 and 18.9x as at<br />
the end of June 2006 continuing to suggest an “easing”<br />
of potential M&A activity. Contrary to North America<br />
and Europe, its balance sheet has strengthened with<br />
net debt EBITDA falling from 1.0 times to 0.97 times.<br />
Furthermore foreign direct investment in Asia is expected<br />
to remain strong, particularly China.<br />
<strong>The</strong> biggest “fallers” contributing to valuation<br />
weakness and therefore falling appetite for deals in<br />
the region are Consumer Services and Oil and Gas.<br />
Consumer Services forward valuation declined 8.7 percent<br />
from 22.5x to 20.6x, with Oil and Gas forward<br />
PE down by 7.1 percent from 12.4x to 11.5x. Only<br />
telecoms remained “warm” with forward PE’s up 9.4<br />
percent to 17.5x with net debt EBITDA remaining<br />
modest and 0.34 times. s<br />
Global fi ndings show the number of deals falling for<br />
the first half year period since H2 2002, and forward<br />
valuations have now been static for four consecutive<br />
half-yearly periods. However, fundamentals still look<br />
sound in the Asia region. Overall, interest rates remain<br />
low and show no signs of any significant increase - the<br />
debt markets are highly competitive although with recent<br />
signs of tightening. Currencies remain robust and<br />
the booming regional resources sector with demand<br />
driven commodity pricing is not expected to slowdown<br />
any time soon. Any fall off in the “price paid” by the<br />
market for earnings streams could signify an easing in<br />
the appetite for assets at perceived inflated levels”. <br />
July-October - 2007 Need the Dough<br />
77
RESEARCH<br />
M&A<br />
DUE DILIGENCE<br />
MORE THAN<br />
JUST FINANCIAL<br />
By Mr. Supriya Mitra Majumdar, Consultant - Legal cum Compliance,<br />
Planman Technologies (India) Pvt. Ltd.<br />
78 Need the Dough July-October - 2007
MERGERS & ACQUISITIONS<br />
<strong>The</strong> Current Scenario:<br />
Between 2005 and 2006, on a year-on-year basis, <strong>global</strong><br />
M&A volume had gone up by 37%. People who deal with<br />
corporate strategies and M&A dealmakers, think that since<br />
the <strong>global</strong> interest rates are still at relatively low levels and<br />
hedge funds have taken an active role in the recent past<br />
in M&A activities, there is a possibility that <strong>global</strong> fund<br />
managers shall continue to allocate more fund for M&A<br />
deals at least in near future.<br />
<strong>The</strong> objective of this article is to focus on the issues of<br />
M&A that require attention of professional managers having<br />
specialization in finance, law, strategies etc., since these<br />
are crucial by nature. It is the fact of life today that the<br />
banks fund M&A mainly for financial reasons realizing<br />
the need for faster growth in volume of business through<br />
inorganic route. Companies make strategic growth plan<br />
through internal operations and acquisition. When mature<br />
resources are needed right away, acquisitions perhaps make<br />
business sense.<br />
Initial Issues:<br />
Internally it should be addressed that when normally M&A<br />
drives fail to generate greater value then why at all a company<br />
should think for it By and large the reason of failure<br />
is poor post-merger integration as a result of which proper<br />
plan for such integration and accountability aspects are to<br />
be drawn up in detail at the strategic plan making stage.<br />
Before placing the matter to the Board, the CEO and his<br />
team should check whether the added resources of the target<br />
company carry any sense to the acquirer Should the<br />
acquisition be made to broaden the product line to reach<br />
a critical market Is it to address a new customer point<br />
Could the brand value of the target be a wealth creator in<br />
the hands of the acquirer<br />
<strong>The</strong>se need to be hammered out to find a logical answer.<br />
Specific issues to be examined like what would be increased<br />
capacity of the acquirer and what would the comparison<br />
look like if compared with its rivals<br />
What was or is the niche market of the target company<br />
and how did the target make value out of its overall business<br />
and is it still possible to create further value What are the<br />
operational hurdles of the target and how the acquirer is<br />
<strong>going</strong> to address such hurdles How the scale of economy<br />
shall show advantageous to the acquirer Lastly, what would<br />
be the incremental cost (interest for borrowing for M&A)<br />
vis-à-vis the incremental volume and the incremental return<br />
on capital<br />
Some Related Issues:<br />
<strong>The</strong> recent M&A deals by Indian business groups abroad<br />
and by non-resident Indians in Europe and US, is perhaps<br />
a positive response to “satisfactory underperformance” as<br />
told by late Sumantra Ghosal. <strong>The</strong>se issues are currently<br />
being deliberated upon at the management schools. While<br />
making analysis relating to M&A strategies some time, it<br />
is not uncommon that the companies forget that may be<br />
a joint venture or a strategic alliance is more flexible than<br />
an acquisition proposal. M&A is an answer for long-term<br />
need or when operations are to be integrated perfectly at<br />
many levels. <strong>The</strong> question of affordability should also be addressed.<br />
In the absence of cash available, private placement,<br />
leveraged buyout could be the source of fund. Funding by<br />
diluting stake of promoter is also not un-common beside<br />
reverse merger. <strong>The</strong> deal maker and the management of the<br />
acquirer should settle these issues upfront, because the funding<br />
model always creates an impact on the future financial<br />
performance of the target and the acquirer. At the legal front<br />
collateral agreements are important between the acquirer<br />
and the investment banker, consultants, lawyers, auditors<br />
in order to avoid confusion and unnecessary disclosure<br />
of confidential matters. <strong>The</strong> management of the acquirer<br />
should develop its team for due diligence and post-merger<br />
integration, to avoid any conflict in the process.<br />
In the absence of cash available,<br />
private placement, leveraged buyout<br />
could be the source of fund<br />
Some Observations:<br />
<strong>The</strong>re are unfortunate instances of due diligence which<br />
echoed the desire of the acquirer in the report and obviously<br />
the M&A failed to be a tool for growth of the combining<br />
entity. Due diligence have the following as source<br />
of information:<br />
1. Public information, public document etc.<br />
2. Research based on feed-back from the customers, suppliers,<br />
distributors, alliance partners, former employees,<br />
competitors, business journalists, analysts and industry<br />
experts.<br />
3. <strong>The</strong> target company, through its management accounts,<br />
interviews with management team.<br />
4. And lastly, own understanding of the acquirer from database<br />
on customer satisfaction and employee turnover<br />
rates etc, and its causes. <strong>The</strong>oretically the due diligence<br />
team should meet regularly during the due diligence period<br />
to exchange their views and findings and the leader<br />
of the team should have courage not to echo the thought<br />
of the owner of the acquirer and should carry sufficient<br />
amount of courage to arrive at a logical and bankable<br />
findings of due diligence report. <strong>The</strong> due diligence team<br />
should have ability to adjust objectives and the scope of<br />
July-October - 2007 Need the Dough<br />
79
RESEARCH<br />
the due diligence if it is necessary,<br />
and should carry necessary mandate<br />
from the acquirer for such purpose.<br />
Unfortunately it is commonly seen<br />
that the due diligence team during<br />
due diligence process take due<br />
diligence to a routine, time bound,<br />
and target oriented exercise. On the<br />
other hand the directors of the acquirer<br />
always want to know whether<br />
the due diligence has been properly<br />
performed, whether the buyer understands<br />
the transaction, whether the<br />
target company is a strategic fit and whether there is a<br />
sound post deal implementation plan. <strong>The</strong>re is increased<br />
board scrutiny on the subject which reflects an awakening<br />
on the implications of risk arising out of due diligence<br />
relating to M&A. <strong>The</strong> Board of the acquirer wants to<br />
know the measures to be adopted to mitigate the risks<br />
arising out of the Merger and Acquisition proposal.<br />
Watson Wyatt’s Worldwide Mergers & Acquisitions Survey<br />
– Asia Pacific shows a difference in approach between<br />
the East and the West on M&A issues. However sector-wise<br />
combination is a continuing trend, mainly to achieve bigger<br />
volume of business and competitive<br />
size beside synergistic resemblance and<br />
cost reduction. However, lack of proper<br />
documentation from the end of the target<br />
company and reluctance on the part<br />
of the target in some cases pose difficulty<br />
in gathering information. This difficulty<br />
was further compounded by a lack of<br />
efficient data collection process in the<br />
acquiring organization and the lack of<br />
time in which to gather information.<br />
<strong>The</strong> survey also states that experienced<br />
acquirers dedicate longer time in making<br />
due diligence in a comprehensive and<br />
realistic manner covering the pertinent<br />
issues involved. A rigorous approach to<br />
commercial due diligence helps acquirers to negotiate better,<br />
reduce risk and perhaps avoid disaster.<br />
80 Need the Dough July-October - 2007<br />
Information gathered through due diligence Scale 0-40<br />
Hard assets 35<br />
Market share, distribution 31<br />
Financial aspects and HR function 30<br />
Management capabilities and willingness to co-operate 26<br />
Technological and business competencies 26<br />
Major shareholders 25<br />
HR Policy matters 20<br />
Workforce potential 19<br />
Organizational culture and dynamics of change 18<br />
Watson Wyatt’s M & A survey discloses the following:<br />
From the above it is apparent that due diligence study makers<br />
give more importance to hard assets and market share<br />
but focus less on workforce potential and organizational<br />
culture. Due diligence makers assume some time that the<br />
knowledge pool or the competency level of the acquirer<br />
is greater and better than the target company. <strong>The</strong>refore,<br />
the intellectual capital and managerial capability are the<br />
two important casualties in normal due diligence process.<br />
Learning ability, sharing ability, adoptability of new<br />
knowledge and courage for further invention are the key<br />
areas through which the level of intellectual capabilities<br />
of any organization could be assessed. <strong>The</strong> due diligence<br />
team through a knowledge audit may try to ascertain the<br />
level of intellectual capital of the target company or may<br />
even reconcile the findings of the knowledge audit with the<br />
acquirer to ascertain its real intellectual strength. <strong>The</strong>se are<br />
issues examined by the due diligence and post deal integration<br />
teams. <strong>The</strong> nature of queries and their response on<br />
the degree of importance is quite signifacant and may be a<br />
Nature of queries Critical Important Unimportant<br />
Retention of key talent 76 21 3<br />
Employee communication 76 18 6<br />
Retention of key managers 74 26 0<br />
Integration of corporate culture 49 49 2<br />
Managing resistance 30 57 13<br />
Labour relation 28 54 18<br />
Alignment of compensation 27 61 12<br />
Retraining workforce 26 58 16<br />
Recruitment of new staff 18 61 21<br />
Redeployment of workers 10 59 31<br />
Downsizing 10 68 22<br />
tool of learning for the management in the process of due<br />
diligence and integration period.<br />
<strong>The</strong> cultural assessment in the pre M&A period and the<br />
alignment of cultures between the target company and the<br />
acquirer is an important element in the post M&A integration<br />
stage. <strong>The</strong>re are instances where poor post-deal integrations<br />
have dampened the acquisition. Experts agree that<br />
mergers generally create value beyond the combined value<br />
of both the targets and the acquirers. Experts also say that<br />
success of M&A depends on adequate pre-deal due diligence<br />
and post deal integration, with the help of findings of due<br />
diligence report of M&A.
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