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CHAPTER 15 MERGERS & ACQUISITIONS CASE- HINDALCOS ACQUISITION OF INDAL

CASE OBJECTIVE: To discuss the rationale of merger and the synergies that emerge from it for both merged and merging companies. Also to determine the exchange ratio (swap ratio) in a merger. DISCUSSION POINTS: Why merger? While contemplating the merger what should be the basis for identifying target firms? The identification of potential target company depends on what is the reason of merger. If the merger is to increase the market share (horizontal merger) then the firms from within the same segment and product line become the potential target. If it is to reduce the risk (conglomerate merger)then unrelated sectors i.e. sectors having negatively correlated income/ cash flows with that of firm become the focus Differentiate between Greenfield and Brownfield expansions . Which of the two should be preferred?(The issues of high magnitude of investment and the long time horizon involved in case of a Greenfield project may be highlighted.) SUGGESTED APPROACH TO THE DISCUSSION QUESTIONS: 1. It is a case of horizontal merger as both the acquiring company (Hindalco) and the acquired company (Indal) are in the same industry having similar product line. Also, they are at the same stage in the value chain. 2. Hindalco is expecting the following gains from the acquisition: A Greenfield project requires not only huge investment but also it takes a long time for the project to become critical. This would imply that Hindalco would have to continue facing the constraints it faces for an extended period. The synergies that are expected to emerge from the acquisition would get deferred and the company would not be in a position to tap the existing demand. Besides the payback period is expected to be shorter in a Greenfield expansion. Increased capacity Access to aluminium reserves and downstream capacity of Indal Enlargement of product basket with more value added products of indal getting added Consolidation would increase the bargaining power and competitive strength Increase the geographical reach and enlarge the consumer base .

3. Expected benefits to Indal are: Certain economies would emerge in form of cost optimization , product rationalization, integration of other processes such as logistics. Certain common activities would be scaled down Better marketing and manufacturing strategies of Hindalco would benefit Indal Access to downstream capacity of Hindalco Expected benefit to the shareholders from of a favourable swap ratio and from increased share value post merger. 4. Determination of Exchange Ratio (ER) in Merger using the LG model (Larson Gonedes) INDAL Total earnings, E (in Rs. lacks) No. of shares outstanding, S (in lacks) Earnings per Share, EPS (Rs.) Price Earnings ratio, PE (Times) Market Price per share, P (Rs.) 117.10 7.11 16.46 7.59 117.05 HINDALCO 686.00 7.45 92.12 6.00 522.60

ER INDAL = (

S INDAL (E INDAL + E HINDALCO ) )+ PE COMBINED FIRM ] S HINDALCO [ P INDAL S HINDALDCO 7.11 7.45 (117.10 686 00) PE COMBINED FIRM ] + 745 )+[ 117.05

ER INDAL = (

Using the above equation the ER Indal can be computed for the various levels of P/E fraction of combined firm. The calculations are given below in the table 15-1.

Similarly the ER can be computed for Hindalco using the following model:

ER

HINDALCO

P [(PE
COMBINED FIRM

HINDALCO

)(E

+E

INDAL

) -P
HINDALCO

S
HINDALCO

INDAL

HINDALCO

ER

HINDALCO

[(PE

COMBINED

FIRM

522.60 7.11 )(117.10 + 686.00) -522.60 7.45]

Using the above equation the ER Hindalco can be computed for the various levels of P/E fraction of the combined firm. The calculations are given in the table15-2.

Table 15-1 PE
Combined firm

Table 15-2 Max. ER INDAL -0.03 0.89 1.81 2.73 3.65 4.57 5.49 6.42 7.34 8.26 9.18 10.10 11.02 11.94 12.87 PE
Combined firm

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Min. ER HINDALCO -1.20 -1.63 -2.51 -5.47 30.03 4.01 2.15 1.47 1.11 0.90 0.75 0.65 0.57 0.51 0.46

Thus ER would be settled somewhere in between the minimum and maximum exchange ratios that have been determined for different levels of expected PE multiples of the combined firm. During the negotiations for the M&A deal Hindalco ltd would like to keep the ER as low as possible while indal would want it to be as high as possible. As the result the AER will lie somewhere between Max. ER and Min. ER. As can be seen in the table, the trade-off point using the LG model lies around a P/E of 6.