MERGERS, ACQUISITIONS, AND

RESTRUCTURING
 OUTLINE
• What is corporate restructuring
• Types of transactions
• Reasons for mergers
• Mechanics of a merger
• Costs and benefits of a merger
• Terms of a merger
• Purchase of a division or plant
• Takeovers
• Strategic alliance
• Managing an acquisitions programme
• Divestitures
• Ownership restructuring
• Privatizations
• Organizational restructuring
• Dynamics of restructuring
 WHAT IS CORPORATE RESTRUCTURING
Corporate restructuring refers to a broad array of activities that expand
or contract a firm’s operations or substantially modify its financial
structure or bring about a significant change in its organizational
structure and internal functioning. Inter alia, it includes activities such as
mergers, purchases of business units, takeovers, slump sales, demergers,
leveraged buyouts, organizational restructuring, and performance
improvement initiatives.
 RESEARCH PAPER
• M&A\IBR_2010_mergers_and_aquisitions.pdf
• M&A\ibr_m_and_a_v2_report_final.pdf
• M&A\M&A_Report_Final.pdf
• M&A\MAI0110.pdf
• M&A\PwC_Asia_MA_2010.pdf
• M&A\PwC_Asia_MandA_2009.pdf
 TYPES OF MERGER

Absorption Consolidation
A+B=A A+B=C

Horizontal Vertical Conglomerate Cogeneric

Takeover
The transfer of control from one ownership group to
another.
Acquisition
The purchase of one firm by another
Merger
The combination of two firms into a new legal entity
A new company is created
Both sets of shareholders have to approve the transaction.
Amalgamation
A genuine merger in which both sets of shareholders must
approve the transaction
Requires a fairness opinion by an independent expert on
the true value of the firm’s shares when a public
minority exists
 CLASSIFICATIONS MERGERS
AND ACQUISITIONS
1. Horizontal
• A merger in which two firms in the same industry combine.
• Often in an attempt to achieve economies of scale and/or scope.
2. Vertical
• A merger in which one firm acquires a supplier or another firm that is
closer to its existing customers.
• Often in an attempt to control supply or distribution channels.
3. Conglomerate
• A merger in which two firms in unrelated businesses combine.
• Purpose is often to ‘diversify’ the company by combining
uncorrelated assets and income streams
4. Cross-border (International) M&As
• A merger or acquisition involving an Indian and a foreign firm.
 REASONS FOR MERGERS
Plausible Reasons
• Strategic benefit
• Economies of scale
• Economies of scope
• Economies of vertical integration
• Complementary resources
• Tax shields
• Utilizations of surplus funds
• Managerial effectiveness
Dubious Reasons
• Diversification
• Lower financing costs
• Earnings growth
 COST AND BENEFITS OF A MERGER

Benefit = PVAB – (PVA + PVB)

Cost = Cash – PVB

NPV to A = Benefit – Cost

= [(PVAB – (PVA + PVB)] – [Cash – PVB]

= PVAB – PVA – Cash

NPV to B = Cash - PVB

 ILLUSTRATION
Firm A has a value of Rs.20 million and firm B has a value of Rs.5
million. If the two firms merge, cost savings with a present value
of Rs.5 million would occur. Firm A proposes to offer Rs.6 million
cash compensation to acquire firm B. Calculate the net present
value of the merger to the two firms.
In this example PVA = Rs.20 million, PVB = Rs.5 million,
PVAB = Rs.30 million, Cash = Rs.6 million. Therefore,

Benefit = PVAB - (PVA + PVB) = Rs.5 million

Cost = Cash - PVB = Rs.1 million

NPV to A = Benefit - Cost = Rs.4 million

NPV to B = Cash - PVB = Rs.1 million
 STOCK VS. CASH
FIXED
SHARES

STOCK

FIXED
VALUE
CASH
QUESTIONS
ARE THE ACQUIRING COMPANY’S SHARES UNDERVALUED, FAIRLY VALUED,
OR OVER VALUED ?
WHAT IS THE RISK THAT THE EXPECTED SYNERGIES NEEDED TO PAY FOR
THE ACQUIS’N PREMIUM WILL NOT MATERIALISE ?
HOW LIKELY … THE VALUE OF THE ACQUIRING CO’s SHARES WILL DROP
BEFORE CLOSING ?
 COMMONLY USED BASES FOR
DETERMINING THE EXCHANGE RATIO
• Earnings per share
• Prima facie reflects earning power
• Fails to consider differences in growth, risk, and quality of earnings
• Market price per share
• In an efficient market, prices reflect earnings, growth, and risk
• The market may be illiquid or manipulated
• Book value per share
• Proponents argue that book values are objective
• Book values reflect subjective judgments and often deviate
significantly from economic values.
• DCF value per share
• Ideally suited when fairly credible business plans and cash flow
projections are available
• It overlooks options embedded in the business
• The merger constitutes the second step of the
combination of Mittal Steel and Arcelor into a single
legal entity governed by Luxembourg law. In the first
step, Mittal Steel merged into ArcelorMittal, by way of
absorption by ArcelorMittal of Mittal Steel and without
liquidation of Mittal Steel. After a vote of the
shareholders of Mittal Steel at an extraordinary general
meeting held on August 28, 2007 and a resolution of the
sole shareholder of ArcelorMittal on August 28, 2007,
this merger became effective on September 3, 2007 and
the combined company was named “ArcelorMittal”.
• In this second and final step, ArcelorMittal (the
surviving entity in the Mittal Steel and ArcelorMittal
merger) will merge into Arcelor and shareholders of
ArcelorMittal will become shareholders of Arcelor,
which will be renamed “ArcelorMittal”.
 MERGER CONSIDERATION
• In the merger, a holder of ArcelorMittal shares
will receive one newly-issued Arcelor share
for every one ArcelorMittal share, which is
referred to as the Exchange Ratio. This
Exchange Ratio assumes the prior completion
of a share capital restructuring of Arcelor
pursuant to which each 7 pre-capital
restructuring shares of Arcelor would be
exchanged for 8 post-capital restructuring
shares of Arcelor.
 FINANCIAL CALCULATION
• M&A\Arcelor Mittal\Excel\Arcelor mittal.xls
• M&A\Arcelor Mittal\Excel\CopyOf09-07-
29ArcelormittalModelQ209Final.xls
 TAKEOVERS
• A takeover generally involves the acquisition of a certain
block of equity capital of a company which enables the
acquirer to exercise control over the affairs of the
company

• A takeover may be done through the following ways

• Open market purchase
• Negotiated acquisition
• Preferential allotment
VALUATION OF FIRMS IN
MERGERS AND ACQUISITIONS
 ISSUES IN ACQUISITION VALUATION

Acquisition valuations are complex, because the valuation often

involved issues like synergy and control, which go beyond just
valuing a target firm. It is important on the right sequence,
including
• When should you consider synergy?
• Where does the method of payment enter the process.
Can synergy be valued, and if so, how?
What is the value of control? How can you estimate the value?
(1) Simplest rationale is undervaluation, i.e., that firms that are undervalued
by
financial markets, relative to true value, will be targeted for acquisition by
those who recognize this anomaly.
(2) A more controversial reason is diversification, with the intent of
stabilizing
earnings and reducing risk.
(3) Synergy refers to the potential additional value from combining two firms,
either from operational or financial sources.
• Operating Synergy can come from higher growth or lower costs
• Financial Synergy can come from tax savings, increased debt capacity or cash
slack.
(4) Poorly managed firms are taken over and restructured by the new
owners,
who lay claim to the additional value.
(5) Managerial self-interest and hubris are the primary, though unstated,
reasons
for many takeovers.
• Equity Valuation Models
- Balance Sheet Valuation Models
• Book Value: the net worth of a company as
shown on the balance sheet.
• Liquidation Value: the value that would be
derived if the firm’s assets were liquidated.
• Replacement Cost: the replacement cost of its
assets less its liabilities.
 Dividend Discount Models

D1 D2 D3
V0     .......
1  k (1  k ) (1  k )
2 3

W here V o = v a lu e o f th e fir m
D i = d iv id e n d in y e a r I
k = d isc o u n t r a te
• The Constant Growth DDM
D0 (1  g ) D0 (1  g )2
V0    ......
1 k (1  k )2

And this equation can be simplified to:

D0 (1  g ) D1
V0  
kg kg

where g = growth rate of dividends.

• Price-Earnings Ratio
P0 1 PVGO
 1
E1 k
 E/k 


wherePVGO=Present Valueof GrowthOpportunity

P0 E 1 (1  b )

E 1 k  ROExb

Implying P/E ratio

P0 1 b

E 1 k  ROExb
where ROE = Return On Equity
• Forecast Performance
- Evaluate the company’s strategic position, company’s
competitive advantages and disadvantages in the industry.
This will help to understand the growth potential and ability
to earn returns over WACC.
- Develop performance scenarios for the company and the
industry and critical events that are likely to impact the
performance.
- Forecast income statement and balance sheet line items
based on the scenarios.
- Check the forecast for reasonableness.
• Estimating The Cost Of Capital
B P S
W A C C  k b (1 - T c )  kp  ks
V V V
w h e re
kb = t h e p r e t a x m a r k e t e x p e c t e d y ie ld t o m a t u r it y o n n o n - c a lla b le , n o n c o n v e r t ib le d e b t
T c = t h e m a r g in a l t a x e r a t e f o r t h e e n t it y b e in g v a lu e d
B = t h e m a r k e t v a lu e o f in t e r e s t - b e a r in g d e b t
kp = t h e a f t e r - t a x c o s t o f c a p it a l f o r p r e f e r r e d s t o c k
P = m a r k e t v a lu e o f t h e p r e f e r r e d s t o c k
ks = t h e m a r k e t d e t e r m in e d o p p o r t u n it y c o s t o f e q u it y c a p it a l
S = t h e m a r k e t v a lu e o f e q u it y

- Develop Target Market Value Weights

- Estimate The Cost of Non-equity Financing
- Estimate The Cost Of Equity Financing
• Estimating The Cost Of Equity Financing
- CAPM
k s  r f   E ( r m )  r f  

w h e re rf = t h e ris k - f r e e ra t e o f re t u r n
E (rm ) = t h e e x p e c t e d r a t e o f r e t u r n o n t h e o v e r a l l m a r k e t p o r t f o l io
E (rm )- rf = m a r k e t r i s k p r e m iu m
В = t h e s y s t e m a t ic r i s k o f e q u it y

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

. Determining The Market Risk premium 5 to 6 percent rate is used for the US companies
. Estimating The Beta
• The Arbitrage Pricing Model (APM)

k s  r f   E ( F 1 )  r f   1   E ( F 2 )  r f   2  ....
w h e r e E ( F k ) = t h e e x p e c t e d r a t e o f r e t u r n o n a p o r t f o lio t h a t m im ic s t h e k t h f a c t o r a n d is
in d e p e n d e n t o f a ll o t h e r s .
B e ta k = t h e s e n t iv it y o f t h e s t o c k r e t u r n t o t h e k t h f a c t o r .
 Synergy – a Quest for Holy Grail
Lessons from history:

• Quaker Oats bought in 1994 Snapple for $ 1,7 bn.

$ 500 mil. lost on announcement, $ 100 mil. a year later
Snapple was spun off 2 years later at 20% of price
• Anheuser-Busch bought in 1982 Campbell-Taggart at $ 560 mil
closed down after 13y of struggling for survival
• IBM bought Lotus for $ 3,2 bn. (more than 100% premium)
probably never to be recouped

October 24 2002 Synergy in Mergers & Acquisitions 40

 Drivers of Synergy
INITIAL FACTORS INTERNAL FACTORS
Method of
Operations
Payment
Strategic System
Relatedness Integration
Control and
Culture
Contested Acquisition SYNERGY
vs. Premium Strategy
Uncontested
Relative
Size
Managerial
Risk Taking

Time

October 24 2002 Synergy in Mergers & Acquisitions 41

 SEBI TAKEOVER CODE
• Disclosure
• Trigger point
• Merchant banker
• Public announcement
• Offer price
• Obligations of the acquirer
• Obligations of the board of the target company
• Competitive bids
• Provision of escrow
• Creeping acquisition
 TAKEOVER DEFENCES

• MAKE PREFERENTIAL ALLOTMENTS

• EFFECT CREEPING ENHANCEMENTS
• SEARCH FOR A WHITE KNIGHT
GESCO … MAHINDRA . . DALMIAS
• SELL THE CROWN JEWELS
• AMALGAMATE GROUP COMPANIES
• RESORT TO BUYBACK OF SHARES
• LOBBY WITH GOVT AND SEBI
BOMBAY DYEING . . BARJORIA
 BUSINESS ALLIANCES
Business alliances such as joint ventures, strategic alliances,
equity partnerships, licensing, franchising alliances, and
network alliances have grown significantly. In many situations,
well-designed business alliances are viable alternatives to
mergers and acquisitions
 COMMON FORMS OF BUSINESS ALLIANCES

• Joint ventures

• Strategic alliances

• Equity partnership

• Licensing

• Franchising alliance

• Network alliance
 RATIONALE FOR BUSINESS ALLIANCES

• Sharing risks and resources

• Access to new markets

• Cost reduction

• Favourable regulatory treatment

• Prelude to acquisition or exit

 COLLECTIVE WISDOM ON MERGERS AND
ACQUISITONS
The extensive research on mergers and acquisitions suggests the
following:
• Mergers and acquisitions thrive during periods of stock market buoyancy.
• Acquirers usually pay too much. This benefits the shareholders of the target
company but hurts the shareholders of the acquiting company.
• CEOs fall in love with deals and don’t walk away when they should.
• Serial acquirers are likely to succeed more than infrequent buyers.
• Compared to purchase of public companies, acquisition of private companies is a

more reliable way of adding value and generating superior returns for buyers.
• Related acquisitions are likely to generate higher returns than unrelated purchases.
• Integration is hard to pull off.
 DIVESTITURES

Mergers, asset purchases, and takeovers lead to

expansion in some way or the other. They are based
on the principle of synergy which says 2 + 2 = 5!
Divestitures, on the other hand, involve some kind of
contraction. It is based on the principle of “anergy”
which says 5 – 3 = 3!
 PARTIAL SELL-OFF
A partial selloff, also called slump sale, involves the sale of a business
unit or plant of one firm to another. It is the mirror image of a
purchase of a business unit or plant. From the seller’s perspective, it
is a form of contraction; from the buyer’s point of view it is a form
of expansion..
Motives for Sell off
• Raising capital
• Curtailment of losses
• Strategic realignment
• Efficiency gain
 DEMERGERS
A demerger results in the transfer by a company of one or more of its
undertakings to another company. The company whose undertaking is
transferred is called the demerged company and the company (or the
companies) to which the undertaking is transferred is referred to as the
resulting company.
A demerger may take the form of a spinoff or a split-up. In a
spinoff an undertaking or division of a company is spun off into an
independent company. After the spinoff, the parent company and the spun
off company are separate corporate entities. In a split-up, a company is
split up into two or more independent companies. As a sequel, the parent
company disappears as a corporate entity and in its place two or more
separate companies emerge.
 EQUITY CARVEOUT

In an equity carveout, a parent company sells a portion of its

equity in a wholly owned subsidiary. The sale may be to the
general investing public or to a strategic investor.
An equity carveout differs from a spin off in the
following ways: (a) In a spinoff the shares of the spun off
company are distributed to the existing shareholders of the
parent company, whereas in an equity carveout the shares
are sold to new investors. (b) An equity carveout brings cash
infusion to the parent company, whereas a spin off does not.
Equity carveouts are undertaken to bring cash to the
parent and to induct a strategic investor in a subsidiary.
 LEVERAGED BUYOUT
A leveraged buyout involves transfer of ownership consummated
mainly with debt. While some leveraged buyouts involve a company
in its entirety, most involve a business unit of a company. Often the
business unit is bought out by its management and such a transaction
is called management buyout (MBO). After the buyout, the company
(or the business unit) invariably becomes a private company.
 SUMMING UP
• Mergers, takeovers, divestitures, spinoffs, and so on, referred to
collectively as corporate restructuring have become a major force
in the financial and economic environment all over the world
• Corporate restructuring can occur in myriad ways. Business firms
resort to a variety of activities that lead to expansion, selloffs, and
changes in ownership and control.
• Mergers represent a very important form of corporate
restructuring. Mergers, as used in financial literature, subsume
both absorption and consolidation.
• A takeover generally involves the acquisition of a certain block of
equity capital of a company which enables the acquirer to exercise
control over the affairs of the company.
ETHICAL ISSUE IN MEREGER AND ACQUISISTION

• What Does Poison Pill Mean?

A strategy used by corporations to discourage hostile
takeovers. With a poison pill, the target company attempts to
make its stock less attractive to the acquirer. There are two
types of poison pills: 

1. A "flip-in" allows existing shareholders (except the

acquirer) to buy more shares at a discount. 

2. A "flip-over" allows stockholders to buy the acquirer's

shares at a discounted price after the merger.
• What Does Scorched Earth Policy Mean?
An anti-takeover strategy that a firm undertakes by
liquidating its valuable and desired assets and assuming
liabilities in an effort to make the proposed takeover
unattractive to the acquiring firm
 
• What Does Suicide Pill Mean?
A defensive strategy by which a target company engages in an
activity that might actually ruin the company rather than
prevent the hostile takeover. Also known as the "Jonestown
Defense."
• What Does Share Purchase Rights Mean?
A type of security that gives the holder the option, but not the
obligation, to purchase a predetermined number of shares at
a predetermined price. This is similar to a stock option or
warrant. These rights are typically distributed to existing
shareholders, who have the ability to trade these rights on an
exchange
• What Does People Pill Mean?
A defensive strategy to ward off a hostile takeover.
Management threatens that, in the event of a takeover, the
entire management team will resign
• What Does Shark Repellent Mean?
Slang term for any one of a number of measures taken by a company to
fend off an unwanted or hostile takeover attempt. In many cases, a
company will make special amendments to its charter or bylaws that
become active only when a takeover attempt is announced or presented
to shareholders with the goal of making the takeover less attractive or
profitable to the acquisitive firm. 

Also known as a "porcupine provision

• What Does Macaroni Defense Mean?
An approach taken by a company that does not want to be taken over.
The company issues a large number of bonds with the condition they
must be redeemed at a high price if the company is taken over
• What Does Lobster Trap Mean?
A strategy used by a target firm to prevent a hostile takeover.
In a lobster trap, the company passes a provision preventing
anyone with more than 10% ownership from converting
convertible securities into voting stock.
• What Does Whitemail Mean?
A strategy that a takeover target uses to try and thwart an
undesired takeover attempt. The target firm issues a large
amount of shares at below-market prices, which the acquiring
company will then have to purchase if it wishes to complete
the takeover
• What Does Sleeping Beauty Mean?
A company that is prime for takeover but has not been
approached by an acquiring company. 
A company may be considered a sleeping beauty because it
has large cash reserves, undervalued real estate, or huge
potential. 
• What Does Sandbag Mean?
A stalling tactic used by management to deter a company that
is showing interest in taking them over.
• What Does Lady Macbeth Strategy Mean?
A corporate-takeover strategy with which a third party poses as a white
knight to gain trust, but then turns around and joins with unfriendly
bidders.
• What Does White Knight Mean?
A company that makes a friendly takeover offer to a target company that
is being faced with a hostile takeover from a separate party.
• What Does Black Knight Mean?
A company that makes a hostile takeover offer on a target company.
• What Does Gray Knight Mean?
A second, unsolicited bidder in a corporate takeover. A gray knight enters
the scene in order to take advantage of any problems between the first
bidder and the target company.

• What Does Yellow Knight Mean?

A company that was once making a takeover attempt but ends up
discussing a merger with the target company. 
• What Does Crown Jewels Mean?
The most valuable unit(s) of a corporation, as defined by characteristics
such as profitability, asset value and  future prospects. The origins of this
term are derived from the most valuable and important treasures
that sovereigns possessed. 
• What Does Bankmail Mean?
An agreement made between a company planning a
takeover and a bank, which prevents the bank from
financing any other potential acquirer's bid.
• What Does Pac Man Mean?
A form of defence used in a hostile takeover
situation. The target firm turns around and tries to
take over the company that has made the hostile
bid.
• What Does Safe Harbor Mean?
1. A legal provision to reduce or eliminate liability as long as good
faith is demonstrated. 

2. A form of shark repellent implemented by a target company

acquiring a business that is so poorly regulated that the target
itself is less attractive. In effect, this gives the target company a
"safe harbor." 

3. An accounting method that avoids legal or tax regulations and

allows for a simpler method (usually) of determining a tax
consequence than those methods described by the precise
language of the tax code.
• In the United States, the anti hostile takeover defences can be categorized into the following
types:Bankmail
• Back-end
• Flip-in
• Crown Jewel Defense
• Golden Parachute
• Flip-over
• Greenmail
• Gray Knight
• Killer bees
• Jonestown Defense
• Lobster trap
• Leveraged recapitalization
• Macaroni Defense
• Lock-up provision
• Non-voting stock
• Nancy Reagan Defense
• Pension parachute
• Pacman Defense
• Poison pill
• People Pill
• Safe Harbor
• Poison Put
• Shark Repellent
• Scorched earth defense
• Standstill agreement
• Staggered board of directors
• Targeted repurchase
• Suicide pill
• Treasury stock
• Top-ups
• Voting plans
• Trigger
• White Squire
• White Knight