mergers and acquisitions overview

8/3/2019 Mergers and Acquisitions Overview

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Mergers and Acquisitions

Overview M&A market trends

Why acquire?

Key conceptsMarket-extension merger

Two companies that sell the same products in different

markets.

Product-extension merger

Two companies selling different but related products in the

same market.


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Why?

Gain market share

Economies of scale

Enter new markets Acquire technology

Utilization of surplus funds

Managerial Effectiveness

Strategic Objective

Vertical integration


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1) Increased Market Power: It is intended to reduce the competitive balance of the industry.

2) Revamping production facilities: To achieve economies of scale by amalgamating production

facilities through more intensive utilization of plant and resources.

3) Financial strength: To improve liquidity and have direct access to cash resource.

4) General gains: To improve its own image and to offer better satisfaction to

consumers or users of the product.

5) Procurement of supplies: To obtain economies of purchase in the form of discount, savings in

transportation costs, overhead costs in buying department, etc.

Reasons for Mergers & Acquisitions


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Conclusion

What works for the company is announced

with much fanfare, but what remainshidden is that what does not work!!!


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1) Integration Facilities: Different Financial & Control Systems can make integration of

firms difficult.

2) Large or Extraordinary Debt:

Costly Debt can create onerous burden on cash outflows.

3) Inadequate Evaluation of Target: Inadequate Evaluation causes acquirer to overpay for the firm.

4) Inability to achieve synergy: Justifying Acquisitions can increase estimate of expected benefits.

5) Overly Diversified: Acquirer doesnt have expertise required to manage unrelated

businesses

Why Mergers & Acquisitions Fail?


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Key Drivers of a Successful

Acquisition

What creates value in an acquisition?

Why do some acquisitions fail? Academic research

Can firms learn to acquire?

Synergy


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Attractiveness of Target

Companies

Structure

Asset Purchase

Business Purchase

Share Purchase

A Mixture

Apportionment of Risk

No Hidden matters Remedy warranty

Indemnity


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Process of Acquisition

Finding A Target Business

Appointing Advisers

Negotiating terms

Due Diligence

Exchange of Contracts Completion


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Culture

M&AStrategy

Resources

Business

Objective

Structure

Leadership

Person


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Taxation and Accountancy

Considerations

Tension between Acquisition / sale of shares

or assets.

Due Diligence

Tricky areas

Accounting issues

Accounting policies of the Target

Accounting for Goodwill

Fair value accounting

Earnings per share

Other Matters


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Negotiating Terms

The nature of the fit

Commonality of client base

Financial strength Strategic intent

Sharing of resources

Applicable Benefits


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Appointing Advisers

The Right Chemistry

The Right Experience

Size is not Everything Talk Your Language


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Finding A Target Business

Synergy of Operations

Help the Organizations to Achieve

Strategic Objectives Enter new markets

Vertical Integration


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Acquisition Structure

Asset purchase

Share purchase

Merger

Hostile

Acquisition accounting fundamentals


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Documentation and Agreements

Confidentiality agreement

Letter of intent Stock purchase agreement

Asset purchase agreement

Fairness opinion


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Sequence of Events

Initial negotiations to closing


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How Does the Integration

Process Affect Value Creation?

Pre merger planning

Post merger planning


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Managing for Value Creation

Key managerial success factors

Merger planning - start at the top


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Valuation

Appraisal Principles

Valuation Methods


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Taxation and Accountancy

Considerations

Tension between Acquisition / sale of shares

or assets.

Due Diligence

Tricky areas

Accounting issues

Accounting policies of the Target

Accounting for Goodwill

Fair value accounting

Earnings per share

Other Matters


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Financing the Acquisition

Financing mix

Consideration

Methods of payment


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VALUATION OF FIRMS INMERGERS AND ACQUISITIONS


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Motives and Determinants of Mergers

Synergy Effect

- Operating Synergy

- Financial Synergy

Diversification

Economic Motives- Horizontal Integration

- Vertical Integration

- Tax Motives

NAV= Vab (Va+Vb) P E

Where Vab = combined value of the 2 firms

Vb = market value of the shares of firm B.

Va = As measure of its own value

P = premium paid for B

E = expenses of the operation


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FIRM VALUATION IN MERGERS AND

ACQUISITIONS-2

Dividend Discount Models

31 2

0 2 3 .......1 (1 ) (1 )

DD D

V k k k!

Where Vo = value of the firm

Di = dividend in year I

k = discount rate


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ACQUISITIONS-3

The Constant Growth DDM

2

0 0

0 2

(1 ) (1 )......

1 (1 )

D g D g V

k k

!

And this equation can be simplified to:

0 10

(1 )D g DV

k g k g

! !

where g = growth rate of dividends.


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ACQUISITIONS-4

Price-Earnings Ratio

0

1

11

/

P PVGO

E k E k

!

-

where PVGO = Present Value of Growth Opportunity

0 1

1

(1 )P E b

E k ROExb

!

Implying P/E ratio

0

1

1P b

E k ROExb

!

where ROE = Return On Equity


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ACQUISITIONS-5

Cash Flow Valuation Models

- The Entity DCF Model : The entity DCF model values the value of a company asthe value of a companys operations less the value of debt and other investor claims,

such as preferred stock, that are superior to common equity. Value of Operations: The value of operations equals the discounted value of expected

future free cash flow.

. Value of Debt

. Value of Equity

Net Operating Profit - Adjusted TaxesContinuing Value =

WACC


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ACQUISITIONS-6

What Drives Cash Flow and Value?

- Fundamentally to increase its value a company must doone or more of the following:

. Increase the level of profits it earns on its existing capitalin place (earn a higher return on invested capital).

. Increase the return on new capital investment.

. Increase its growth rate but only as long as the return onnew capital exceeds WACC.

. Reduce its cost of capital.


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ACQUISITIONS-7

The Economic Profit Model: The value of a companyequals the amount of capital invested plus a premium equal to the

present value of the value created each year going forward.

Pr ( ) Economic ofit Invested Capital x ROIC WACC! where ROIC = Return on Invested Capital

WACC = Weighted Average Cost of Capital

Pr ( ) Economic ofit NOPL AT Invested Capital x WACC!

where NOPLAT = Net Operating Profit Less Adjusted Taxes

Value=Invested Capital+Present Value of Projected Economic Profit


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STEPS IN VALUATION

Analyzing Historical Performance

NOPLATReturn on Investment Capital =Invested Capital

FCF = Gross Cash Flow Gross Inves tments

Economic Profit = NOPLAT (Invested Capital x WACC)


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STEPS IN VALUATION-2

Forecast Performance- Evaluate the companys strategic position, companys

competitive advantages and disadvantages in theindustry. This will help to understand the growth potentialand ability to earn returns over WACC.

- Develop performance scenarios for the company and theindustry and critical events that are likely to impact theperformance.

- Forecast income statement and balance sheet line itemsbased on the scenarios.

- Check the forecast for reasonableness.


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Estimating The Cost Of Capital

- Develop Target Market Value Weights

- Estimate The Cost of Non-equity Financing

- Estimate The Cost Of Equity Financing

(1- )b c p s

B P SWACC k T k k

V V V!

where

kb = the pretax market expected yield to maturity on non-callable, non convertible debt

Tc = the marginal taxe rate for the entity being valuedB = the market value of interest-bearing debt

kp = the after-tax cost of capital for preferred stock

P = market value of the preferred stock

ks = the market determined opportunity cost of equity capital

S = the market value of equity


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Estimating The Cost Of Equity Financing

- CAPM

. Determining the Risk-free Rate (10-year bond rate)

. Determining The Market Risk premium 5 to 6 percent rate is used for the UScompanies

. Estimating The Beta

( ) s f m f

k r E r r F ! -

where rf = the risk-free rate of return

E(rm) = the expected rate of return on the overall market portfolio

E(rm)- rf = market risk premium

= the systematic risk of equity


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The Arbitrage Pricing Model (APM)

1 1 2 2( ) ( ) ....

s f f f k r E F r E F r F F ! - -

where E(Fk) = the expected rate of return on a portfolio that mimics the kth factor and is

independent of all others.

Beta k = the sentivity of the stock return to the kth factor.


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Estimating The Continuing Value- Selecting an Appropriate Technique

. Long explicit forecast approach

. Growing free cash flow perpetuity formula

. Economic profit technique

T+1 T+1Economic Profit (NOPLAT )( / )( )

CV = +( )

g ROIC ROIC WACC

WACC WACC WACC g

where

Economic Profit T+1

= the normalized economic profit in the first year after the explicitforecast period.

NOPLAT T+1 = the normalized NOPLAT in the first year after the explicit forecast period.

g = the expected growth rate of return in NOPLAT in perpetuity

ROIC = the expected rate of return on net new investment.

WACC = weighted average cost of capital


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Calculating and Interpreting Results

- Calculating And Testing The Results

- Interpreting The Results Within TheDecision Context


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Anti-takeover Mechanisms

Poison pills and other defensive measures

Anti-trust Policies


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I believe this will be the first step in

showing that Indian industry can stepoutside the shores of India in an

international market place and acquit

itself as a global player

- Ratan Tata

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