Mergers and Acquisition

Mergers and Acquisitions
METs Institute of Management Studies
Mergers and Acquisitions . Law Project
Submitted by: Kunal Mehra Girish Nair Abhishek Pawar Chetan Zaveri Priya Malvekar Sagar Kubal Geeta Mullik Jacob Malekal Rakesh Pal 89 93 79 81 87 83 95 85 97
CONTENTS
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I II III IV V VI VII
Strategies Behind Corporate Restructuring Legal Aspects of Mergers and Acquisitions Accounting and Taxation Aspects Funding and Valuation Case Studies Key Terminology Bibliography
3-12 13-19 20-30 31-43 44-61 62 63
Corporate Restructuring
It can be defined as
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1 Any change in the business capacity or portfolio that is carried out by an inorganic route i.e A company which goes for expansion in business portfolio through inorganic route and not organic route. A company which goes for business expansion through organic route cannot be termed as corporate restructuring. Example: Tata Motors launched sumo and indica but under tata motors own manufacturing capacity so it is not corporate restructuring since the expanding organically. Similarly, acquisition of Jaguar Land rover from ford by tata motors through its step down subsidiary jaguar land rover limited qualifies to be called corporate restructuring. 2 Any change in the capital structure of a company that is not in the ordinary course of its business i.e any substancial change in the debt and equity structure of the company for a long term duration example: Initial Public offer, Follow-on-public issue or buy back of equity shares which would permanently alter the capital structure of a company. 3 Any change in the ownership of a company or control over its management or a combination of any two or all of the above i.e Merger of two companies belonging to different promoters, Demerger of a company with control of the resulting company passing on to other promoters, acquisition of a company, Sell-off of a company or its substantial assets, delisting of a company.
Main Forms of Corporate Restructuring

a) Merger It Involves combination of all the assets , liabilities, loans and businesses ( on a going concern basis) of two (or more) companies such that one of them survives A Limited Paid up equity capital of Rs 10 crore (1 crore shares of face value Rs 10each) B Limited Paid up equity capital of Rs 50 crore (5 crore shares of face value Rs 10each) A Limited is Proposed to be merged with B limited with swap ratio of 5:2
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After the merger Shareholders of A limited will get 40 Lakh Shares of face value Rs 10 each of B Limited in exchange of shares of A limited. Shares of A Ltd will get cancelled since A ltd will cease to exist through a legal process called dissolution without winding up. All assets and liabilties of A ltd will be transferred to B Ltd So equity capital of B ltd will show a Equity Capital of Rs 54 crore. And A ltd will conduct its business under the name of B ltd. All rights exercised by A ltd against the 3rd parties will be exercised by B ltd and Vice versa. Example: RPL merged with Reliance Industries Ltd with a swap ratio of 16:1 b) Consolidation It creates an altogether a new company owning assets, liabilities, loans and businesses (on going concern basis) of two or more companies, both/all of which cease to exist. A Limited Paid up equity capital of Rs 10 crore (1 crore shares of face value Rs 10each) B Limited Paid up equity capital of Rs 50 crore (5 crore shares of face value Rs 10each) For every 2 shares held A ltd will get 1 share of C ltd and for every 5 shares of B ltd will get 2 shares of C ltd. After Consolidation C ltd can to existence Shares of A ltd and B ltd will get cancelled since both companies will cease to exist through a legal process called dissolution without winding up.
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The Balance sheet of C ltd will have equity capital of Rs 25 crore ( A ltd will get 50 lakh shares of face value of rs 10 each of C Ltd and B ltd will get 200 lakh equity shares of C ltd) Business of A ltd and B Ltd will be conducted under the name of C limited. All exercisable rights go to C ltd Example: Andrew Carnegies steel company Morgans Federal Steel Company along with 5 other companies were consolidated to form US steel company c) Acquisition Acquisition is an attempt or a process by which a company or an individual or a group of individuals aquires control over another company called target company. There are many ways in which control over a company can be acquired a) by acquiring substantial percentage of the voting capital of the target company b) by acquiring voting rights of the target company through a power of attorney or through a proxy voting arrangement c) by acquiring control over an investment or holding company whether listed or unlisted, that in turn holds controlling interest in the target company. d) By simply acquiring management control through a formal or informal understanding or agreement with the existing persons in control of the target company. Substantial Acquisition of shares can lead to three situation: a) The existing promoters is getting dislodged as promoters and the acquirer e an stepping into their shoes and becoming the promoter. This is called successful acquisition. b) The acquired managing to acquire more or less the same percentage or a little less percentage of shareholding than the existing promoters , thereby getting fair representation on the board and some say in the management of the target company but not being able to dislodge the existing promoters. This would be a partially unsuccessful acquisition.
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Mergers and Acquisitions c) The acquirer not managing to get any really substantial percentage of share capital. This
would be an unsuccessful acquisition. Example: Acquisition of Ranbaxy by Daiichi Sankyo d) Divestiture It means an out and out sale of all or substantially all the assets of the company or any of its business undertakings/divisions, usually for cash. (or for combination of cash and debt) and not against equity shares. The Consideration is normally payable in cash for two reasons
a) The Divesting/transferor company needs cash to pay off liabilities and secured/unsecured
loans. b) Most of the time divestiture is done to bring cash into the company for pumping into remaining business or to start a new business. Divestiture is normally used to mobilize resources for core business or businesses of the company by realizing value of non-core business assets. Example: Camlin Ltd was into three core business Consumer Product Division, Pharmaceutical Division and Fine Chemical Division. The PD division was making losses and hence divestiture the PD division e) Demerger It can take three forms: Spin Off Transfer of all assets, liabilities, loans and business (on a going concern basis) of one of the business divisions to another company whose shares are allotted to the shareholders of the transferor company on a proportionate basis. Split up
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Transfer of all assets, liabilities, loans and business (on a going concern basis) of the business to another company whose shares are allotted to the shareholders of the transferor company on a proportionate basis. The difference between Spin off and split up is that in split up the transferor company ceases to exist. Spin off and Split up are resorted to achieve focus in the respective businesses. Split Off In Split off the shareholders get shares in the transferee company in exchange of shares in the transferor company. Basically it is realigning the holding of the promoters. Example: De-merger of Indian Aluminum Company Ltd- INDAL into HINDALCO f) Carve out It is a Combination of Divestiture and Spin-Off. In Carve out, a company transfers all the assets, liabilities, loans and businesses of one of its divisions to its 100 per cent subsidiary. Example: AT&Ts 1996 ownership restructuring provides a striking example. Before the company announced that it would spin off Lucent Technologies and NCR, its market value was just $75 billion. Little more than a year later, in January 1998, the separately trading AT&T, Lucent, and NCR had a combined market capitalization of $159 billion.
g) Joint Venture It is an arrangement in which two or more companies (Called the joint venture partners) contribute to the equity capital of a new company (called joint venture) in pre decided proportion. Example: Maruti Suzuki - A joint venture project between Government of India and Suzuki Corporation h) Reduction of Capital
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A Company can reduce its capital on any of its shares in which share capital is not paid up or by writing off or canceling the capital which is lost (Accumulated loss that goes beyond the reserves) or by paying off or returning excess capital that is not required by the company. i) Buy- Back of Securities When a company is holding excess cash which it does not require in the medium term it is better for the company to return the excess cash to the shareholders. Company can do this by buying back the shares. j) Delisting of Securities/Company In this we are talking about delisting of equity shares from all the stock exchanges. This is done if the company is in no need of public funds , does not want to incur the extra cost in terms of providing different reports and does not want to share a lot of information in public domain.
Mergers and Acquisitions as a Growth Strategy

Different Classes of Growth Opportunities: 1) Intensive growth a) Market Penetration It involves a company seeking increased sales for its present products in the present markets through more aggressive marketing efforts. Ex: Pepsi & Coca Cola b) Market Development It consists of a company seeking increased sales by taking its existing products into new markets.
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Mergers and Acquisitions Ujala a brand of Jyoti Laboratories was a market leader in South India however over the
years it has made its presence in the western part of India.

c) Product Development
It consists of a company seeking increased sales by developing improved products for its present markets. Example: Nokia introduces a new model from its staple every 4-6 months. 2) Integrative Growth a) Backward Integration It Consist of a company seeking ownership or increased control of its supply system. b) Forward Integration It consists of a company seeking ownership or increased control of its distribution system. c) Horizontal Integration It consists of a company seeking ownership or increased control of its competitors. Example: RIL started with Vimal range of fabrics went to backward of polyester fiber, RIL getting into setting up petrol pumps , Grasim acquiring L& T cement business Ultra Tech Cement 3) Diversification growth a) Concentric diversification It consists of a company seeking to add new products that have technological or marketing synergies with the existing products. These products will normally appeal to new classes of customers. b) Horizontal diversification It consists of a company seeking to add new products that could appeal to its present customers though technically unrelated to its present product line.
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c) Conglomerate diversification It consists of a company seeking to add new products for new classes of customers, with no relationship to the companys current technology, products or markets. Thus we can conclude that inorganic growth strategy can be deployed in almost all the strategies of growth except market penetration. Example : Launch of Sumo and Indica by Tata Motors Levis garment manufacturing co into deodorants and leather accessories ITC into cigarette and hotels
Mergers and Acquisitions and their Motives:

1) Monopoly Theory Monopoly theory works in three ways: a) Market leaders trying to consolidate their position further
b) Profitable and cash rich companies trying to gain market leadership
c) Market entry strategy Example: Mittal Steel Acquiring Arcelor 2) Efficiency Theory This theory explains M&A as being planned and executed to achieve synergies Synergies can be broadly classified into two: 1) Revenue generating synergies 2) Cost reduction synergies Example: ICICI with ICICI Bank In this there are five main types of Synergies: a) Manufacturing synergy
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Involves combining core competence of the Acquirer Company and Target Company in the different areas of manufacturing, technology, design etc. Example: Daiichi Sankyo and Ranbaxy- R&D strength of Daiichi b) Operations synergy Involves rationalizing the combined operations in such a manner that through sharing of facilities duplication is avoided or logistics is improved leading to quantum cost saving. Example: Kingfisher Airlines acquiring Deccan Airways c) Marketing Synergy Involves using either common sales force or distribution channel to push the products and brands of both the acquirer and target companies at lower cost. Example: Hindustan Lever acquired Lakmes brand and business. d) Financial synergy Involves achieving reduction in the weighted average cost of capital or other improved financial parameters by combining both the companies balance sheets. Example: RPL with RIL used for funding its Greenfield project through par issue of Group Company e) Tax synergy Involves merging a loss-making company with a profitable one so that the profitable company can get the tax benefit by writing off accumulated losses of the loss-making company against its profits of the profit-making company. Example: 3) Valuation Theory
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It is being planned and executed by the acquirer who has better information about the valuation of the target and who estimates the real value to be much higher than the present market capitalization of the company. Example: Hindustan Zinc Ltd buy Sterlite Ltd 4) Raider Theory In this the acquirer (Private Equity Funds) acquires controlling stake in cash needy companies at much lower valuation than potential valuation or even present valuation without any strategic intent of running these companies themselves. 5) Empire Building theory It is planned and executed by the managers for expanding their own empire rather than creating shareholder wealth.
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LEGAL ASPECT OF MERGER AND ACQUISITION 1. (a) (I) (II) (III) (b) (c) (d) (e) (f)
(g)
Conditions of Buy-back and General Obligations the Company A company can buy back its shares or other specified securities only by any of the From existing share/security holders on a proportionate basis through tender offer. From open market through : Book building process Stock exchange From odd lot shares A company cannot buy back its shares or other specified securities in such a manner that Consideration for buy-back has to be paid in cash only. A company cannot withdraw the offer to buy back after the draft letter of offer has been A company cannot issue any shares or other specified securities including by way of The promoters of their associates cannot deal in the shares or other specified securities of No public announcement of a buy-back can be made during the pendency of any scheme A company intending to buy back its shares or other specified securities has to appoint a Details of shares bought back and extinguished and destroyed have to be informed to the A company cannot buy back locked-in securities during the lock-in period. Within two days of the completion of buy back, the company has to issue a public
following methods :
it would be required to delist.
filed with SEBI or the public announcement of the offer to buy back has been made. bonus shares till the date of closure of the offer. the company in the stock exchange during the period the buy- back offer is open. of amalgamation or arrangement or compromise. (h)
(i)
compliance officer and investor service centre. concern stock exchange(S) within seven days of the extinguishment and destruction. (j) (k)
announcement giving certain details and in a prescribed manner.
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2.
Requirement of the Special and Boared Resolutions In case, where a special resolution is passed in the general meeting, the explanatory
(a)
statement to the notice of general meeting should contain information as per schedule I of regulations. (b) (c) A copy of the special resolution passed should be field with SEBI and the relevant stock With regard to the buy-back made under the board resolution, apart from the company exchange(s) within seven days of the passing. being required to file a copy of board resolution with SEBI and relevant stock exchange(S) within two days, it is also required to give a public notice in the least one English national daily, one Hindi national daily and one regional daily within two days of passing of the resolutions. 3. (a) (i)
(ii)
Buy back through Tender Offer and Buy back through Book Building Process Escrow Account An escrow account is required to be opened on or before the opening of the open offer. In case , the total considerations payable under buy-back does not exceed Rs. 100 crore,
the amount to be deposited in the escrow account shall be 25 per cent of the consideration payable. However , if the consideration payable is in excess of Rs. 100 crore, the amount would be 25 per cent of the first Rs.100 crore and 10 per cent of the excess over Rs. 100 crore. (iii) The deposit in the escrow account can be in the form of cash deposited with a scheduled commercial bank or bank guarantee in favour of the merchant banker or acceptable securities with an appropriate margin deposited with the merchant banker or a combination thereof. However, a minimum of 1 per cent of the total consideration payable must be in the form of cash deposited with the scheduled commercial bank. (iv) So far as the cash deposited with a commercial bank is concerned , upon closure of the tender offer, 90 per cent thereof can be utilized by transfer to the special account to be opened for payment of consideration to be security holders. The regulation further requires the company to immediately fund the balance amount to make up the entire amount due.
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(v)
Bank guarantees and securities deposited in the escrow account, however , can be
returned to the company only after the payment of consideration has been fully made and all formalities relating to the tender offer have been fully completed.
1.
(a)
Definitions Acquirer means a person who, directly or indirectly, acquirers or agrees to acquire shares
or voting rights in the target company or acquires or agrees to acquire control over the target company, either by himself or with any person acting in concert with the acquirer [regulation 2 (1) (b)]. (b) Control shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue agreements or in any other manner [regulation 2 (1) (c)] (c) Person acting in concert [regulation 2 (1) (e)] For considering that a person is acting in concert with the acquirer it must be proved that the acuirer and the said person have or had a common objective or purpose of either making substantial acquisition of shares or voting rights or getting control over the target company ant that there is or was an agreement or understanding (whether formal or informal) between them. It also must be proved that pursuant to this agreement or understanding they have or had cooperated with each other by acquiring or agreeing to acquire shares or voting rights in or control over the target company. Further , the regulations list out certain categories of persons or entities that if one of them in is an acquirer, others within the category, by virtue of their relation or business relationship could be generally deemed to be (presumed to be) acting in concert, unless proved to the contrary. (d) Promoter means any person who is in control of the target company or who has been named as a promoter either in the offer document or in any shareholding pattern field with the stock exchange(S) under the listing agreement whichever is later. In addition, a promoter also means any person belonging to the Promoter Group as defined in the explanation. This is like a deeming provision[regulation 2 (1) (h)].
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(e)
Target Company means a listed company whose shares or voting rights or control is
directly or indirectly acquired or being acquired [ regulation 2 (1) (O). 2. (a) (b) (c) (d) (e) (f) (g) (h) (i) Exemptions from Applicability of Regulations 10, 11 and 12 (Regulation 3) Allotment in public issue subject to the conditions discussed in the main text above. Allotment in a rights issue subject to the conditions discussed in the main text above. Allotment to underwriters which is du to development. Inter se transfer, subject to various conditions discussed in the main text above, of shares Persons constituting a group as defined by the MRTP Act, 1969 Relatives within the meaning of section 6 of the Companies Act, 1956 Qualifying Indian promoters and their foreign collaborators who are shareholders Qualifying promoters Acquirer and persons acting in concert with him Acquisition of shares in the ordinary course of Business By registered stock brokers on behalf of clients, By registered market makers during the course of market making, By public financial institutions on their on account By banks and public financial institutions as pledges, By certain stipulated international financial institutions like IFC, ADB, etc. By the merchant banker or the promoter of the target company under a safety net scheme acquisition of shares received in exchange of the shares held in another company for Shares acquired through inheritance. Transfer of shares from the registered venture capital funds or foreign venture capital Acquisition of shares under any SICA, 1985 scheme or in any arrangement or
Some of the important exemptions are :
amongst :
under SEBI (DIP) Guidelines, 2000. which an open offeras made
investors to the promoters of the venture capital undertaking. reconstruction including amalgamation or demerger under any Indian or foreign law,
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(j) (k) 3.
Acquisition of shares in an unlisted company. Acquisition of shares in terms of SEBI ( Delisting of Securities) Guidelines, 2003. Relaxation from the strict Compliance with the Provisions of Chapter II
Under newly inserted regulation 29A, SEBI is empowered to grant relaxation from strict compliance of provisions of chapter III to those target companies which meet all the conditions stipulated therein 4. (a) Triggers of Open Offer (Regulations 10, 11 and 12) No acquirer any shares or voting rights which taken together with his existing holdings
and shareholdings of the persons acting in concert would aggregate to 15 per cent or more without making pulic announcement of an open offer ( regulation 10). (b) No acquirer , who along with the persons acting in concert, is holding 15 per cent or more but less than 55 per cent of shares or voting rights in a company can acquire, either by himself or through or with the persons acting in concert, more than 5 per cent of shares or voting rights in any financial year without making a public announcement of open offer. This is called creeping acquisition [regulation 11(1)]
(c)
No acquirer , who along with the person acting in concert, is already holding 55 per cent
or more but less than 75 per cent of shares or voting rights in a company can acquire any shares or voting rights without making an offer. In case of the companies who have been allowed to list, with only 10 per cent offered to public, this rule applies to holding between 55 and 90 per cent[regulation 11 (2)] The above position under regulation 11 (2) has recently undergone a change. Vide an amendment dated 30 October 2008, to the sub - regulation 11 (2) , SEBI has now permitted the promoters holding between 55 per cent and less than 75 per cent to Acquire up to 5 per cent ( in a financial year) without making an open offer provided such acquisition is made through open market purchase in the normal segment on the stock exchange only. (d) The provisions of regulations 10 and 11 apply to the direct acquisition in a listed company and to the indirect acquisition by virtue of the acquisitions of companies, irrespective of whether listed or unlisted and whether in India or abroad.
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Mergers and Acquisitions (e)
Regulation 12 requires that irrespective of whether there has been any acquisition of
shares or voting rights, no acquirer can acquire control over a target company without making a public announcement of an open offer. This regulation applies to the direct, as well as, the indirect acquisition of contract of the target company By virtue of acquisition of another company, irrespective of whether such another company is listed or unlisted and whether it is registered in India or abroad. This , however, does not apply if such change of control takes place by the target companys shareholders passing a special resolution in a general meeting . I . Minimum Offer Price and Modes of Payment Consideration (Regulation 20) (a) Modes of Payment Consideration
Regulation 20 (2) permits that the offer price could be paid In cash By issue, exchange or transfer of the enquiry shares of the acquirer company (if the acquirer is a body corporate) By issue, exchange or transfer of the secured debt instruments of the acquirer company (if the acquirer is a body corporate) By any combination of the above three methods
However , in case, the acquirer has made cash payment for the acquisition of any shares of the same class, whether in the open market or through negotiated deal or otherwise , within twelve months prior to the public announcement , he has to give option to the shareholders to accept payment in cash instead of by exchange of shares or securities. Further , in case there is a revision in the offer price or size (i.e. number of shares offered to be acquired), an acquirer can alter the mode of payment , subject , however, that the cash amount (per share) cannot be reduced. Regulation 20 (3) , stipulates that in the event, the offer price consists of an amount payable in the form of any securities, and such issue of securities requires the acquirer ( company) to obtain its shareholders approval, the acquirer (company) has to obtain the same within seven days of the closure of the open offer, failing which the entire consideration needs to be paid in cash.
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(b) Frequently and infrequently traded shares
Sub regulation (4) of regulation 20 deals with the rules of what should be the minimum offer price in case the target companys shares are frequently traded on a stock exchange or exchanges, whereas, sub regulation (5) deals with the situation where they are infrequently traded. The provisions regarding when shares are to be considered as infrequently traded are given in the explanation to regulation (5). They are as follows : In case , the annualized number of shares traded on a stock exchange in the six calendar months, prior to the calendar month in which the public announcement for open offer is made , is less than 5 per cent of the number of shares listed, the shares shall be considered as infrequently traded. In case , the target company has got some shares listed during the period of these months, then the weighted average of the listed shares during the period of six months has to be considered. In case, the target company is a PSU , then the six month period is the six calendar months prior to the month in which the Indian Government opens the financial bid. In case, the target company has been listed foe less than six months preceding (the month in which) the public announcement of open offer, then the trading turnover is to be annualized with reference to the actual number of days for which it is traded.
II. Minimum Size of the Open Offer ( Regulation 21 ) Generally , the minimum size of open offer shall be 20 per cent of the voting capital of the company. Further , if such acquisition results into the public shareholding falling below the minimum public holding required under the listing agreement, (i.e. 25 percent or 10 per cent as the case may be), the acquirer has to, within the time stipulated in the listing agreement, take such steps to ensure that the public shareholding is restored to the minimum required level.
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In case of an acquirer making open offer under regulation 11 (2A), i.e. an acquirer holding more than 55 per cent but less than 75 or 90 per cent as the case may be, such acquirer has two choices : 1. Make an offer for 20 per cent and then ensure that the public shareholding is restored to the minimum required level
Or
2. Make an open offer for such a percentage (lesser than 20 per cent ) so that the shares acquired in the open offer together with the shares already held by him and persons acting in concert with him add up to such percentage (i.e. 75 or 90) , thereby maintaining the minimum required public shareholding (i.e. 25 or 10 as the case may be )
( c ) Regulations 21A Provides that an acquirer can make an offer conditional to the minimum level of acceptance and such percentage can be less than 20.
III. Competitive Bid The regulations relating to a competitive bid are as follows : (a) Public announcement of a competitive bid can be made within twenty-one days of the public announcement of the first open offer and not thereafter. (b) There can be competitive bid in case of a PSU disinvestment (c) Any competitive offer must be made for such a minimum number of shares so that the shares offered together with those already held by the competitive bidder shall be equal to the number of shares that the first bidder would hold if his offer fully succeeds. (d) Upon the public announcement of a competitive bid, the first acquirer has a right to revise upward his offer within fourteen days of the public announcement of the competitive open offer. In case , he does not revise his offer within fourteen days, his earlier continues to be valid ( and binding upon him ) on its original terms and conditions except that the date of the closure (e)
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of his offer shall now be the same as the date of the closure of the public offer of the last subsisting bid. ( e) The acquirer and the competitive bidder(s) have an option to make upward revisions (i.e., any number of upward revisions) either in the price or in the number of shares to be acquired up to seven days prior to the date of the closure of the offer. (f) Original and competitive bids shall close on the same date which is the date of closure of the last subsisting bid. (g) There can be no competitive bid in case of open offers made under newly inserted regulation 29a, (e.g. open offer by Tech Mahindra to the shareholders of Satyam).
HUMAN ASPECTS OF M&A
The period of merger is a period of great uncertainty for the employees at all levels of the merging organizations. The uncertainty relates to job security and status within the company leading to fear and hence low morale among the employees and quite naturally so. The influx of new employees into an organization also creates a sense of invasion at times and ultimately leads to resentment. Moreover, the general chaos which follows any merger results in disorientation due to ill defined roles and responsibilities. This leads to frustrations resulting into poor performance and low productivity since strategic and financial advantage is generally a motive for any merger. The top executives involved in implementation of merger often overlook the human aspect of mergers by neglecting the culture shocks facing the merger. Understanding different cultures and where and how to integrate them properly is vital to the success of an acquisition or a merger. Important factors to be taken note of would include the mechanism of corporate control particularly encompassing delegation of power and power of control, responsibility towards management information system, interdivisional and intra-divisional harmony and achieving optimum results through changes and motivation.
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The key to a successful M&A transaction is an effective integration that is capable of achieving the benefits intended. It is at the integration stage immediately following the closing of the transaction that many well-conceived transactions fail. Although often overlooked in the rush of events that typically precede the closing of the transaction, it is at the integration stage with careful planning and execution that plays an important role which, in the end, is essential to a successful transaction. Integration issues, to the extent possible, should be identified during the due diligence phase, which should comprise both financial and HR exercises, to help to mitigate transaction risk and increase likelihood of integration success.
ACCOUNTING OF AMALGAMATION AND DEMERGERS Accounting Standard (AS) 14* (Issued 1994) Accounting Standard 14 (AS 14), issued by the Council of the Institute of Chartered Accountants of India came into effect in respect of accounting periods commencing on or after 1st April, 1995. This is a mandatory accounting standard for amalgamation required to be followed by all companies.
CLASSIFICATION OF AMALGAMATION Amalgamation by way of Merger Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions:
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(i) (ii)
All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company. Shareholders holding not less than 90%of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.
(iii)
The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.
(iv) (v)
The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company. No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.
Amalgamation by way of Purchase Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified above. METHODS OF ACCOUNTING FOR AMALGAMATIONS There are two main methods of accounting for amalgamations: (a) The pooling of interests method; and (b) The purchase method.
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(a) The pooling of interests method The use of the pooling of interests method is confined to circumstances which meet the criteria referred to an amalgamation in the nature of merger. In preparing the transferee companys financial statements, the assets, liabilities and reserves (whether capital or revenue or arising on revaluation) of the transferor company should be recorded at their existing carrying amounts and in the same form as at the time of amalgamation. In other words, no adjustment in the value as appearing in the transferor companys books is permitted. Further, all assets, liabilities and reserves have to be accounted under the same account heads under which they were appearing. To take an example in case of a bulk drug plant, if the transferor company has been accounting the bulk drug plant building as plant and machinery, the transferee company will also have to account it as plant and machinery, Similarly, in case of transferor company, being a land developer, has shown its stock in trade, even if its objective behind this merger was to acquire this land bank for constructing its factory and therefore, from its perspective it is more correctly accounted as land under fixed assets and not as stock in trade. Post amalgamation, it may convert this stock in trade in to a fixed asset, but not at the time of amalgamation if it is adopting the pooling of interests method of accounting. Alternatively, if the transferee company is bent upon accounting for this land bank as a fixed asset at the time of amalgamation itself, it will have to follow purchase method of accounting. If the amalgamation is an amalgamation in the nature of merger, the identity of the reserves is preserved and they appear in the financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company. Thus, for example, the General Reserve of the transferor company becomes the General Reserve of the transferee company, the Capital Reserve of the transferor company becomes the Capital Reserve of the transferee company and the Revaluation Reserve of the transferor company becomes the
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Revaluation Reserve of the transferee company. As a result of preserving the identity, reserves which are available for distribution as dividend before the amalgamation would also be available for distribution as dividend after the amalgamation. The difference between the amount recorded as share capital issued (plus any additional consideration in the form of cash or other assets) and the amount of share capital of the transferor company is adjusted in reserves in the financial statements of the transferee company.
(b) The purchase method Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified in the amalgamation by way of merger, is known as amalgamation by way of purchase. In such a case, while preparing its financial statements, the transferee company is required to follow the purchase method of accounting. With regard to assets and liabilities, the transferee company can record the assets and liabilities of the transferor company at their existing carrying values, i.e. book values or allocate the consideration to the individual identifiable assets and liabilities on the basis of their fair values at the date of amalgamation. The transferee can account for the transferor companys assets at fair values instead of book values. However, the wordings used in AS 14 are very restrictive. Their strict interpretation would mean that the assets can be accounted at their fair values only by consideration paid is higher than the net book value of the assets i.e. book value of assets minus liabilities and borrowed funds) taken over, wherein the transferee company can utilize the goodwill (in part or in full) to enhance the values of the assets to bring them upto their fair values. For accounting of demergers, the Income Tax Act, 1961 has stipulated certain norms. They are as follows:
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(a) (b)
All the assets and liabilities of the undertaking being demerged must be transferred to the resulting company and must be transferred at book valued only. Liabilities and loans have to be transferred in the following manner: (i) (ii) Specific liabilities of the demerging undertaking must be transferred to the resulting company. Specific loans or borrowing including debentures raised, incurred and utilized solely for the activities and operations of the demerging undertaking must be transferred to the resulting company. (iii) Common loans and borrowings must be apportioned to the resulting company in the same ratio as the book value of the assets transferred to the resulting company bears to the total book value of the assets of the demerged company prior to the demerger.
TAXATION ASPECTS OF AMALGAMATION AND DEMERGER Amalgamation "Amalgamation", in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that (i) All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation; (ii) All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation; (iii) Shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation, otherwise than as a
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result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first mentioned company Demerger (19AA) "Demerger", in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manner that (i) All the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger; (ii) All the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger; (iii) The property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger; (iv) (v) The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis; The shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company; (vi) (vii) The transfer of the undertaking is on a going concern basis; The demerger is in accordance with the conditions, if any, notified under sub-section of section 72A by the Central Government in this behalf. Explanation 1 : For the purposes of this clause, "undertaking" shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but
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does not include individual assets or liabilities or any combination thereof not constituting a business activity. Explanation 2 : For the purposes of this clause, the liabilities referred to in sub-clause (ii), shall include - (a) The liabilities which arise out of the activities or operations of the undertaking IMPLICATIONS IN TERMS OF CAPITAL GAINS TAX Following transactions in relation to amalgamations and demergers are not treated as transfer of a capital asset, and therefore no capital gains tax is chargeable. (a) Transfer of a capital asset in the scheme of amalgamation, if the amalgamated company is an Indian Company. (b) Transfer of a capital asset in the scheme of demerger, if the resulting company is an Indian company. (c) Allotment of shares in an amalgamated company in lieu of shares of an amalgamating company if (i) (ii) the transfer is in consideration of the shares of the amalgamated company Amalgamated company is an Indian Company
(d) Any issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company. (e) Transfer of shares in an Indian company held by a foreign company to another foreign company under the scheme of amalgamation of two foreign companies provided (i) (ii) At least 25 percent of the share holders of the amalgamating foreign company continue to be the share holders of the amalgamated foreign company. Such transfer attracts no capital gains tax in the country in which the amalgamating company is incorporated (f) Transfer of shares held in an Indian company by a demerged foreign company to the resulting foreign company provided (i) (ii) at least 75 percent of the share holders of the demerged foreign company continue to be the share holders of the resulting foreign company Such transfer attracts no capital gains tax in the country in which the amalgamating company is incorporated.
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IMPLICATIONS IN TERMS OF CARRY FORWARD AND SET OFF OF LOSSES AND UNABSORBED DEPRECIATION Section 72 of the Act provides that when a loss (including unabsorbed depreciation) under the head profits and gains of business or profession cannot be set off against the income under the same head or under a different head in the same year, because of the absence or inadequacy of income of the same year, it may be carried forward and set off against the profits of any business in the subsequent years. The loss can be carried forward only for eight assessment years subsequent to the assessment year in which it was incurred, unabsorbed depreciation can be carried forward indefinitely. However, one main condition of such carry forward and set off is that the loss can be carried forward and set off by the same assessee. Example: If an amalgamating company has accumulated losses, and amalgamated company, being a different assessee would not have been entitled to carry forward and set off losses against its future profits. Same would have been the case in respect of losses of the undertaking being demerged which the resulting company a different assessee could not have claimed after the demerger. In order to resolve this, Section 72A provides certain exceptions to the rule that the loss can be carried forward and set off by the same assessee. Two of these exceptions are amalgamations and demergers. Under section 72A, the accumulated loss and unabsorbed depreciation of an amalgamating company are deemed to be the carried forward of loss/depreciation of the amalgamating company for the previous year in which amalgamation had taken place provided the following conditions are met:
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(i)
The amalgamation company has to be an industrial undertaking, ship or a hotel or a banking company amalgamating with SBI or a subsidiary of SBI. From the current year, this benefit is also extended to the amalgamation of a PSU airline with another PSU airline. Industrial undertaking is an undertaking which is engaged in:
Manufacturing or processing of goods Manufacturing of computer software Generation or distribution of electricity Mining Construction of ships, aircrafts or rail systems Providing telecommunication services whether basic or cellular or paging Providing domestic satellite services, network of trucking, broadband network and internet services
(ii) (iii)
The amalgamating company has been engaged in the business in which the accumulated loss or unabsorbed depreciation has occurred at least for three years. The amalgamation company has held continuously as on the date of amalgamation, at least three-fourth of the book value of the fixed assets held by it two years prior to the date of amalgamation.
(iv)
The amalgamated company continues to hold at least three fourth of the book value of the amalgamating companys fixed assets for five years from the date of amalgamation.
(v) (vi)
The amalgamated company continues the business of the amalgamating company at least for a period of five years from the date of amalgamation. The amalgamated company achieves at least 50 percent capacity utilization before the end of the fourth year and continues the level achieved till the end of the fifth year.
A benefit of Section 72A is restricted only to a certain sections such as manufacturing, mining, electricity, telecom, hotels, software, shipping, etc. The entire service sector, which now accounts for close to 50 per cent of the gross domestic product is denied of this benefit. Companies in the industries such as healthcare, financial services, retail chains, business process
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outsourcing (BPOs), knowledge process outsourcing (KPOs), advertisement agencies, private airlines and so on cannot avail of the benefit of section 72A. The condition that the amalgamating company should have been in a business for a minimum of three years prior to amalgamation really serves no purpose. Because of this condition, even if within a year or two of starting business, a company sees the writing on the wall that to become profitable and viable it needs to merge with another company, it would be forced to continue accumulating further losses till three years are over. Similarly, forcing an amalgamated company to continue amalgamating companys business for five years is an unwarranted provision. Amalgamation should not be allowed to be used purely for tax avoidance. But that objective can be achieved in a different manner. For that purpose, forcing an amalgamated company to continue for five years, the loss-making business whose revival appears to be impossible, is ensuring value destruction for the shareholders. The motive behind compelling the amalgamated company to hold at least three-fourth of the book value of the amalgamating companys fixed assets for five years is to avoid asset stripping, the provision is ineffectual. Asset stripping is primarily done in case of surplus land and real estate. Companies who have bought the land fifty, thirty or even twenty years back had them at throw away prices in comparison to the present land prices. This provision cannot come in the way of asset stripping by sale of such lands, It would only come in the way of replacement of old, junk, outdated plant and machinery whose value in the books would account for substantial percentage of the total book value of assets at the time of amalgamation However, the companies have to abide by the law in section 72A being what it is, in case they want to carry forward the amalgamation companys losses and unabsorbed depreciation in the books of amalgamated company and reduce its future tax liability. One good thing about section 72A though, is that the losses of the amalgamating company that are carried forward in the books of amalgamated company, are treated as the amalgamated companys losses for the year in which the amalgamation takes place, thereby enabling them to be carried forwards for a further full period of eight years.
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In case of demerger also, section 72A allows/requires the resulting company to carry forward and claim the accumulated loss and unabsorbed depreciation to the following extent: (a) In case the loss/depreciation is directly related to the undertaking transferred to the resulting company, then the whole of such loss/depreciation has to be carried forward (b) In case the loss/depreciation is common to the retained and transferred undertakings, then the loss apportioned on the basis of book value of assets transferred and retained, has to be carried forward. Reverse Mergers Reverse merger is defined in two ways: (i) (ii) Where a holding company merges with the subsidiary or investee company Were a profit-making company is merged with the loss making company
This second concept of reverse merger is relevant from income tax point of view. As the benefits of section 72A is available only to certain sectors to the exclusion of a large number of other sectors, mainly service sectors. In case of a reverse merger, since profit-making company is merger with the loss-making one, the surviving entity is the erstwhile loss-making company. With this, the condition that the same assessee has to carry forward and set off the loss is satisfied and the merged entity can, in future, set off the past losses against the future combined profits.
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Methods of effecting payment of consideration. a) b) c) d) By issue of equity shares of the acquirer company By issue of preference shares of the acquirer company By issue of secured debt instruments of the acquirer company By payment in cash
By issue of equity shares of the acquirer company In this method, an acquirer company issues it shares to the shareholders of the target company in exchange of shares of the target company in a specified ratio as a swap ratio and hence this method is commonly known as share swap method. Swap ratio or exchange ratio is simply the ratio of the price offered for acquiring one equity share of the target company divided by the valuation of one equity share of the acquirer company. By issue of preference shares of the acquirer company
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SEBI takeover regulations do not permit issuance of preference shares in lieu of payment of consideration for share acquired from the public during the course of an open offer. However, the prohibition does not apply in case of negotiated block deal entered into by the acquirer company with the existing promoters or institutional shareholders prior to the open offer. However, normally, the existing promoters or institutional shareholders wanting to cash out their investment in the target companys shares would prefer only cash. Hence, even this method is also not much workable. It is possible that if the takeover is being initiated by the institutional investor due to their unhappiness with the present promoters, they may accept preference shares medium-term maturity at an attractive dividend rate as a method of funding the acquirer company that may not be cash rich but capable of running the target company far better. However, even in such a situation, the cleaner route would be that the acquirer company separately mobilizes cash by issuance of preference shares to the institutional investor and effects payment of consideration in cash so mobilized. In any case, there are as of now known instances of such a transaction.
By issue of secured debt instruments of the acquirer company If the acquirer company is a well known company with an excellent financial health, its triple A or double A rated secured debt instrument carrying attractive coupon rate would be well accepted by the tendering company. However, the chances of acceptance of such instruments instead of cash would be better if the company resorts to differential pricing and also if such debt instruments are on a stock exchange with national trading providing liquidity. No doubt, differential pricing would increase the apparent cost of acquisition. However, if the debt instrument is structured imaginatively, the company can reduce the differential between its time value adjusted cost and upfront cash payment, while at the same time making it attractive to at least a sizeable section of the tendering shareholders. Listing of such instruments that are not being offered to public at large through the process of public offering may be almost impossible. However the acquirer company can provide liquidity to them by having arrangements with the banks or Non-Banking Finance Companies (NBFC) for providing loans against the same or for buying them out at discounted rates.
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Thus, used imaginatively, secured debt instruments can be an effective method of payment of consideration for those acquirer companies that are not cash rich but have management expertise in substantially improving the performance and cash flows of the target companies. By payment in cash This is of course the most favored method for effecting payment to the tendering shareholders. It is both clean and transparent and well accepted by the selling shareholders.
Sources of Funds :
DOMESTIC ACQUISITIONS EQUITY a) Internal Accrual For most of the domestic acquisitions, the primary source of funding is internal accruals. Acquisition is a game that is normally played by the cash rich companies who are looking at growth opportunities through acquisitions using surplus cash. Also, despite banking reforms and liberalization over last fifteen years, till very recently, Indian banks have not been enthusiastic about lending for acquisitions. Though scenario now is changing internal accruals still remain the primary source of acquiring funding. b) IPO / FPO Initial Public Offering (IPO) by an unlisted company, with the major objective of mobilizing funds for acquisitions is unlikely to be successful in the market. Even if the issue is not for mobilizing funds for acquisitions and there other fund requirements for various organic growth initiatives, market would not be comfortable to fund such predator whose performance in the stock market is yet to be tested. FPO is a very time- consuming and expensive process. Hence, if a company were to mobilize funds after initiating the process of acquisition of the target company, it cannot complete the FPO process before money is actually required to be paid to the target companys shareholders.
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c) Rights Issue Rights Issue is an effective post acquisition route to mobilize funds for repayment of bridge loans taken from the banks and financial institutions for acquisition. d) Private Placement / PE Funds Private equity funds or PE funds are astute investors who understand the acquisition game very well. They are also prone to take high risks (in return of high rewards). Further, the process of mobilizing funds from PE funds is much faster. Hence, this is one very much viable route of mobilizing fund for acquisitions. e) ADRs / GDRs Use of funds mobilized through issuance of American Depository Receipts (ADRSs) and Global Depository Receipts (GDRs) is not permitted for acquiring the company or a part thereof in India except that the ADR/GDR proceeds can be utilized for the first stage acquisition of shares in the disinvestment process of public sector undertaking / enterprises and also in the mandatory second stage offer to the public.
BORROWED FUNDS Banks & FIs Private sector banks and branches / subsidiaries of Foreign banks are more proactive in lending for acquisition as compared to PSU banks. Further, so far as the domestic acquisition is concerned, banks normally prefer to extend short-term funding through bridge loans or subscriptions to commercial paper, though they are open to lending medium-term loans also. Financial Institutions like Infrastructure Development Finance Company Ltd (IDFC)and Housing Development Finance Corporation Ltd (HDFC)are known to have better appetite for lending medium-term loans for acquisitions. Use of External Commercial Borrowings funds is not permitted for acquiring a company or a part thereof in India. CROSS BORDER ACQUISITIONS by an INDIAN COMPANY
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EQUITY a) Internal Accruals The Ticket Size of Global Acquisition is a significant portion of or even in excess of the net worth of the Indian acquirer company, internal accruals cannot be a major or primary source4 of funding global acquisitions. b) Rights Issue A Company can come out with a rights issue so as mobilize the funds for the payment consideration. Many Indian companies have come issued rights for the funding and purchase of the company or a part of it. c) ADRs/GDRs In terms of the RBI regulations not only ADR/GDR proceeds can be used for acquisitions of foreign companies, such usage is outside the limit of 400 % of the net worth as also without limit. With regard to foreign currency convertible bonds (FCCB) however, it is a part of the limit of 400 % of net worth. Many large Indian Companies use ADR, GDR and FCCB to create a war chest before going on acquisition spree.
BORROWED FUNDS a) Foreign Banks & FIs Funding from foreign banks and FIs plays a significant role in cross border acquisitions by Indian companies. Foreign Banks , funds and even foreign branches of Indian Banks have been lending to reputed Indian corporate for cross border acquisitions. Foreign banks and institution give long term loans as well as short term/ bridge loans. b) External Commercial Borrowings (ECBs) ECBs can be used to raise resources for cross border acquisitions. However, they have to be a part of the limit of 400% of net worth. Tata Steel raised ECB of US$500 million as a part of the finance its contribution of US$4.9 billion. Leverage Buyout
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Leverage Buyout (LBO) simplistically means mobilizing borrowed funds based on the security of assets and cash flows of the target company (before its taken over) and using those funds to acquire the target company. a) Incorporation of a privately / wholly owned company to act as a special purpose vehicle (SPV) for acquisition of a target company. b) Mobilization of borrowed funds in the SPV, based on the security of the assets and cash flows of the target company (before its taken over) c) Acquisition of the entire or near entire share capital of the company. d) Merger of the target company into the SPV. This last move, which is also a critical step in the leveraged buyout, has two effects: (i) It brings the assets of the Target Company and loans taken by the SPV into one balance sheet by which the lenders security no more remains a third party security. (ii) It makes the target company go private, i.e., the target company gets unlisted. Example: The Acquisition of Corus Plc by Tata Steel is the case of leveraged Buyout. Debt mobilization was also done by both the SPVS. While Tata steel UK mobilized $6.14 billion on the security of assets and cash flow of Corus PLC and Tata steel Asia mobilized bridge loans of $ 2.66 billion. Management buyout When the professional management or non-promoter management of a company carries out a leveraged buyout of the company from its promoters, the same is called as a Management buyout or MBO Example: Private equity fund Blackstone has concluded Indias largest management buyout deal till now. The US fund has backed the management of Intel net Global, the BPO promoted by
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HDFC and Barclays Bank Plc, to buy out the company reportedly for $200 million. The private equity fund will retain 80 per cent, while the management will hold 20 per cent of the company. Around 300-400 employees in the senior management of Intel net will become shareholders in the firm.Blackstone Valuation of Target Companies Valuation of a target company is a very special step in the process of acquisition. Often, the acquirers end up valuing and paying for the target companies far more than their intrinsic value. This happens either due to over optimism about the potential synergies or over estimation of ones own ability to create value in the target company or simply due to euphoria or even due to desperation to conclude the acquisition or an emergence of a competitive bid. In such a situation the acquisition ends up destroying the value, particularly for the shareholders of the acquirer company. Hence, very cautious but not pessimistic valuation of a target company is a key step in the success of an acquisition. Concepts and their relevance to valuing a Target Company Book Value This is essentially accounting concepts. Accounts are written on the basis of historical cost minus the depreciation on depreciable assets. Even the debt is recorded at its historical cost and not market value. Hence, the concepts book value in generic sense means historical cost as recorded in the books of accounts. In relation to equity shares, it means net worth divided by the number of outstanding shares. Net worth, in turn, means difference between book value of assets of the firm minus book value of its liabilities minus book value of outstanding preference shares, if any. This value actually does not reflect value or worth of a share, but rather reflects its historical cost Reinstatement or replacement value This is an amount that a company would be required to spend if it were to replace all its existing assets by identical condition as existing assets. There are many conceptual and practical flaws in this concept which are:
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1. Identical assets may not be available in the market any more. 2. Identical capacity assets may not available any more. 3. One can only acquire new assets and therefore, adjustment in valuation for identical condition value will have to be hypothetically and subjectively superimposed. 4. This concept ignores value of intangibles and value of existing assets which are still capable generating cash flows. 5. This concept totally ignores the ability or otherwise of a company to generate future cash flows and their magnitude. Liquidation Value or Break-up Value This means market value of all assets of a company, if sold piecemeal after the closure of the business. This concept also ignores the value of intangibles. It rather assumes the value of intangible as zero. Further, this concept assumes the closure of business and thereafter is not relevant at all for valuing a target company, wherein one needs to find out its intrinsic value on a going concern basis. However, in case the target company is having non-operating assets of substantial value, say a large piece of land, that, when sold after acquisitions, would bring substantial cash flow into the target company, then the liquidation value of such assets (suitably discounted depending upon the estimated timing of inflow and cost of capital) would have to be added to the enterprise value arrived at ongoing concern basis. On the other hand, from the target companys point of view, especially one that is not financial sound and hence is being taken over, liquidation value is the minimum or floor value which it need not accept any bid. Market Value Market value of an asset or a security is a price at which it is currently being traded in the market. Market value of a company .i.e. market capitalization means number of outstanding equity shares multiplied by the market price of the share. This is also not a true measure of the value or intrinsic value of a company for a number of reasons. Intrinsic value of a company means its long term sustainable value. Long-term investors need to take account into long term sustainable value and not the short term market price. Acquisition of a target company is certainly a long term investment from the acquirer perspective, and he needs to look at the
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intrinsic value while first deciding if the target is worthwhile the acquisition and thereafter in deciding the maximum price, including control premium, beyond which he should not pay. Present Value of Future Cash Flows Correct definition of value or intrinsic value of a company is the present value of its net future cash flows discounted at the weighted average cost of its capital (WACC). a) Net Cash flows mean cash flows from operations as adjusted for capital expenditure (CAPEX) and changes in net working capital (NWC) b) WACC or weighted average cost of capital is the weighted average of the specific cost of capital of various funding components of the firm, weights being either book value or market value of each of the funding components. A firm or a company invests its capital (pooled from various sources of funding such as debt, preference shares and equity shares) in assets with an objective of earning return on the same in the form of future cash flows. If these cash flows are generated at a rate of return on capital employed (ROCE) or return on invested capital (ROIC), which is just equal to the WACC, then the firms value will remain stagnant and will equal the capital invested. If the rate of return is higher than the WACC, the firms valuation will be higher than the invested capital, whereas, returns at a rate below WACC would destroy the valuation and bring it below the invested capital. Therefore, those firms, There are a number of acquisition valuation methods. While the most common is discounted cash flow, it is best to evaluate a number of alternative methods, and compare their results to see if several approaches arrive at approximately the same general valuation. This gives the buyer solid grounds for making its offer. Using a variety of methods is especially important for valuing newer target companies with minimal historical results, and especially for those growing quickly all of their cash is being used for growth, so cash flow is an inadequate basis for valuation. Valuation Based on Stock Market Price If the target company is publicly held, then the buyer can simply base its valuation on the current market price per share, multiplied by the number of shares outstanding. The actual price
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paid is usually higher, since the buyer must also account for the control premium. The current trading price of a companys stock is not a good valuation tool if the stock is thinly traded. In this case, a small number of trades can alter the market price to a substantial extent, so that the buyers estimate is far off from the value it would normally assign to the target. Most target companies do not issue publicly traded stock, so other methods must be used to derive their valuation. When a private company wants to be valued using a market price, it can adopt the unusual ploy of filing for an initial public offering while also being courted by the buyer. By doing so, the buyer is forced to make an offer that is near the market valuation at which the target expects its stock to be traded. If the buyer declines to bid that high, then the target still has the option of going public and realizing value by selling shares to the general public. However, given the expensive control measures mandated by the Sarbanes-Oxley Act and the stock lockup periods required for many new public companies, a targets shareholders are usually more than willing to accept a buyout offer if the price is reasonably close to the targets expected market value.
Valuation Based on a Multiple Another option is to use a revenue multiple or EBITDA multiple. It is quite easy to look up the market capitalizations and financial information for thousands of publicly held companies. The buyer then converts this information into a multiples table, which itemizes a selection of valuations within the consulting industry. The table should be restricted to comparable companies in the same industry as that of the seller, and of roughly the same market capitalization. If some of the information for other companies is unusually high or low, then eliminate these outlying values in order to obtain a median value for the companys size range. Also, it is better to use a multi-day average of market prices, since these figures are subject to significant daily fluctuation. The buyer can then use this table to derive an approximation of the price to be paid for a target company. For example, if a target has sales of $100 million, and the market capitalization for
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several public companies in the same revenue range is 1.4 times revenue, then the buyer could value the target at $140 million. This method is most useful for a turn-around situation or a fast growth company, where there are few profits (if any). However, the revenue multiple method only pays attention to the first line of the income statement and completely ignores profitability. To avoid the risk of paying too much based on a revenue multiple, it is also possible to compile an EBITDA (i.e., earnings before interest, taxes, depreciation, and amortization) multiple for the same group of comparable public companies, and use that information to value the target. Better yet, use both the revenue multiple and the EBITDA multiple in concert. If the revenue multiple reveals a high valuation and the EBITDA multiple a low one, then it is entirely possible that the target is essentially buying revenues with low-margin products or services, or extending credit to financially weak customers. Conversely, if the revenue multiple yields a lower valuation than the EBITDA multiple, this is more indicative of a late-stage company that is essentially a cash cow, or one where management is cutting costs to increase profits, but possibly at the expense of harming revenue growth. If the comparable company provides one-year projections, then the revenue multiple can be renamed a trailing multiple (for historical 12-month revenue), and the forecast can be used as the basis for a forward multiple (for projected 12-month revenue). The forward multiple gives a better estimate of value, because it incorporates expectations about the future. The forward multiple should only be used if the forecast comes from guidance that is issued by a public company. The company knows that its stock price will drop if it does not achieve its forecast, so the forecast is unlikely to be aggressive. Revenue multiples are the best technique for valuing high-growth companies, since these entities are usually pouring resources into their growth, and have minimal profits to report. Such companies clearly have a great deal of value, but it is not revealed through their profitability numbers. However, multiples can be misleading. When acquisitions occur within an industry, the best financial performers with the fewest underlying problems are the choicest acquisition targets, and therefore will be acquired first. When other companies in the same area later put themselves up for sale, they will use the earlier multiples to justify similarly high prices. However, because they may have lower market shares, higher cost structures, older products, and so on, the
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multiples may not be valid. Thus, it is useful to know some of the underlying characteristics of the companies that were previously sold, to see if the comparable multiple should be applied to the current target company. Valuation Based on Enterprise Value Another possibility is to replace the market capitalization figure in the table with enterprise value. The enterprise value is a companys market capitalization, plus its total debt outstanding, minus any cash on hand. In essence, it is a companys theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, while pocketing any remaining cash. Valuation Based on Comparable Transactions Another way to value an acquisition is to use a database of comparable transactions to determine what was paid for other recent acquisitions. Investment bankers have access to this information through a variety of private databases, while a great deal of information can be collected on-line through public filings or press releases. Valuation Based on Real Estate Values The buyer can also derive a valuation based on a targets underlying real estate values. This method only works in those isolated cases where the target has a substantial real estate portfolio. For example, in the retailing industry, where some chains own the property on which their stores are situated, the value of the real estate is greater than the cash flow generated by the stores themselves. In cases where the business is financially troubled, it is entirely possible that the purchase price is based entirely on the underlying real estate, with the operations of the business itself being valued at essentially zero. The buyer then uses the value of the real estate as the primary reason for completing the deal. In some situations, the prospective buyer has no real estate experience, and so is more likely to heavily discount the potential value of any real estate when making an offer. If the seller wishes to increase its price, it could consider selling the real estate prior to the sale transaction. By doing so, it converts a potential real estate sale price (which might otherwise be discounted by the buyer) into an achieved sale with cash in the bank, and may also record a one-time gain on its books based on the asset sale, which may have a positive impact on its sale price. Valuation Based on Product Development Costs
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If a target has products that the buyer could develop in-house, then an alternative valuation method is to compare the cost of in-house development to the cost of acquiring the completed product through the target. This type of valuation is especially important if the market is expanding rapidly right now, and the buyer will otherwise forego sales if it takes the time to pursue an in-house development path. In this case, the proper valuation technique is to combine the cost of an in-house development effort with the present value of profits foregone by waiting to complete the in-house project. Interestingly, this is the only valuation technique where most of the source material comes from the buyers financial statements, rather than those of the seller. Valuation Based on Liquidation Value The most conservative valuation method of all is the liquidation value method. This is an analysis of what the selling entity would be worth if all of its assets were to be sold off. This method assumes that the ongoing value of the company as a business entity is eliminated, leaving the individual auction prices at which its fixed assets, properties, and other assets can be sold off, less any outstanding liabilities. It is useful for the buyer to at least estimate this number, so that it can determine its downside risk in case it completes the acquisition, but the acquired business then fails utterly. Valuation Based on Replacement Cost The replacement value method yields a somewhat higher valuation than the liquidation value method. Under this approach, the buyer calculates what it would cost to duplicate the target company. The analysis addresses the replacement of the sellers key infrastructure. This can yield surprising results if the seller owns infrastructure that originally required lengthy regulatory approval. For example, if the seller owns a chain of mountain huts that are located on government property, it is essentially impossible to replace them at all, or only at vast expense. An additional factor in this analysis is the time required to replace the target. If the time period for replacement is considerable, the buyer may be forced to pay a premium in order to gain quick access to a key market. While all of the above methods can be used for valuation, they usually supplement the primary method, which is the discounted cash flow method.
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Case Studies Acquisition of Corus by Tata Steel- The Mega Deal

Tata Steels takeover of Anglo Dutch steel giant Corus is a major milestone in the history of Indian Business. The 13.7$ billion deal is one of the biggest takeover in the history of Indian Corporate history. It re-affirmed the arrival of India as the big player in the globalization game.
Highlights of the Acquisition
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Tata steel acquired Corus which was four time its size and the largest steel producer in the U.K The acquisition have taken Tata Steel into the big league From being fifty-sixth position in the world Tata steel when merged with Corus and other subsidiaries is the fifth largest player in the steel market Indias largest ever Trans-Border acquisition A classic case of leveraged Buyout with 70% being financed through Debt Indian companies combined for global acquisitions were over $10billion; Corus deal exceeded all of them put together. Nine round bid with CSN Brazil through a very highly competitive auction process. The Victory On 31st January 2007 Tata steel acquired Anglo Dutch steel producer for US$12.90 billion it has stiff competition from CSN the Brazilian Giants and had to go through nine rounds before finally clinching the deal. Tata steel can now use Corus strong marketing network in Europe and high expertise in making high end, high value added grades of steels used in automobiles, construction and aerospace can also be leverage for Tatas supplies in Indian global markets, on the other hand Corus can draw upon Tata steel expertise in low cost manufacturing of steels. Initially Tata steel had offered a much lower price at 455 pence per share valuing the deal at roughly about US$8 billion; however the final offer of 608 pence per share was made to pip CSN who had made an offer of 603 pence per share. There were two views on the deal from the industry experts as Corus reported lower profits inn 2006 many market analyst felt that at 608 pence paid by Tata was too high and considering it was an all cash deal the acquisition would be a financial burden for Tata steel. This is because the acquisition price of 608 pence translated into an enterprise value at $710 per tonne of steel capacity.
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The then MD of Tata steel B Muthuraman felt and quoted that it was important to have the right utilization of assets to create value to the business and share holders and Tata will benefit from the synergies although it will take roughly about 3 years time to make this happen. In context Ratan Tata had individual and national pride associated to this whole deal though there were many critics against the price that was paid. The fact is that the deal was done and Tata along with Corus became the fifth largest player in the global steel market and competing with the likes of Arcelor-Mittal, POSC0 The History of Tata Steel Tata steel is a part of the Tata Group one of the largest diversified business conglomerates in India. Tata group companies generates revenues of about 1, 00,000 crores and the group market capitalization was roughly about $63 billion dollars at the time of the acquisition despite the fact that only 28 of the 96 Tata group companies were listed. It all began in 1907 through one visionary JRD Tata it started it operations in West Bengal which had high reserves for Iron ore and water. Within no time Tata steel grew and it could produce about 70,000 tones per year during that era. It also played a major role in IInd World war being one of the main suppliers of steel required for manufacturing shells and armoured cars. It expanded it business and with liberalization in the Indian economy in the 1990 it rapidly became the Asias first and Indias largest integrated steel producer in the private sector. In 2000 it commissioned its Cold Rolling Mill plant at Jamshedpur. Tata has been influential in building the city of Jamshedpur. The city was adopted by Tata and its plant in this city is considered to be one of the best steel plants in the world. In Feb 2005, Tata steel acquired the Singapore based steel manufacturer Nat steel limited. Nat steel owned steel mills in Australia, China, Philippines, Thailand and Vietnam. With this acquisition the company gained access to the Asian Market and Pacific Markets. To further strengthen it position in the industry it acquired Thailand based Millennium Steel in December 2005. These acquisitions not only helped Tata steel to strengthen its position in major Asian Markets but also provided it with an additional customer base for 2 million tones of steel.
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For the Financial year 2006-07 it net sales was at Rs 17,500 crore with a PAT of Rs 4,200 crore.
The History of Corus The history of Corus can be tracked way back to the 20th century when the Government of Netherlands established Konninklijke Hoogovens. The idea of establishing this was to enable the Dutch industry to be less dependent on the import of steel; moreover it had good access to sea for the supply of raw materials and export of finished goods. The company was established on the North Sea coast which had good access to the North Sea Canal. Like Tata it did with the strategy of several acquisitions over the decade and became one of the major players in the European Steel Industry. By 1990 it had diversified into many divisions like steel, aluminum, steel processing, automobile component, aerospace and construction industries. One of the major achievements was it was selected as the long term European supplier to Boeing. The company also won major awards for continuous improvement from big industry giants like Volkswagen, Audi, and Toyota & Duracell In 1999 it merged with British Steel Plc to form Corus Group the third largest steel producer that time.Hoogovens held 38.3% of the stake and balance 61.7% by British Steel. The merger was primarily done to review British steel who was struggling and had huge financial loss incurred during that period. Though it was formed to review the industry the loss kept on mounting due to low price of steel and the Pound sterling gains against the euro worked against the company. During the period 2003 to 2006 various cost cutting exercise were undertaken and loss were reduced to 50% prior to 2003. In 2006 Corus reported an annual turnover of Pound 9.7Billion but with a much lower PBT of Pound 313 million.
History of the Deal
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CSN and Corus had planned an all shares merger in 2002 but the deal eventually broke up. According to CSN it changed it plans once it had a close look at Corus books. Corus on the other hand counter claimed that it was one that had walked away citing ongoing uncertainties in the global business environment. In 2006 a strategic decision was taken to join hands with low cost steel producer and this is how Tata steel initially made an offer of 455 pence per share in Oct 2006 for an all cash deal taking full control of Corus valuing the deal for about $8 billion dollars. This was considered were low by market experts but Tata continued to maintain its offer at the price it had offered and finally Corus agreed to the deal as it felt it was the right partner keeping in mind the interest of both the shareholders and the employees. Tata offer and Corus acceptance resulted in a CSN making a counter offer and this process continued with each day passing by. Due to this pierce competition the takeover Panel, the United Kingdom watch dog on Mergers & Acquisitions set a deadline of 30 th January for both the companies to make the final offer. It also suggested that if no outright winner emerged, an auction would be conducted. Despite of getting this ultimatum none of the companies offered there final price to acquire Corus. The panel had to finally resort for an auction and it was decided that the same would be conducted after the closing hours of London Stock Exchange on 31st Jan 2007. After nine rounds of bidding Tata Steel emerged the winner in the auction with its final bid of 608 pence per share. Though in the London Stock exchange Corus share rose by approximately 7% to 602 pence it was reverse in the Indian case, Indian investors were unhappy about the premium Tata had paid to acquire Corus. Tata steel share prices fell 11% on the Bombay Stock Exchange. In the press conference after the auction concluded Ratan Tata said that the market was harsh about the deal.
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He Quoted One makes the mistake of taking a short-term view of a corporation and its life. It would take several years for us to build a 19million tonne enterprise from scratch, leave alone establishing in Europe.
Industry Scenario In the year 2000-2007 the global steel industry rapidly expanded both in terms of demand and capacity creation. At the time of the acquisition the overall out look of the industry was very bullish. This was the main driving force to make such a giant acquisition and such a big risk. The global crude steel production in 2007 was 1344 million tones showing an increase of 100 million tones over the 2006 level. China had been the main contributor to the growth in production. Its production had gone up 300% and it led both in terms of production and consumption of steel globally. The global steel capacity also grew a whopping 47%. It was strategically very important for Tata and a big opportunity to make its presence felt in the global market. Indian steel industry had experienced a robust growth in demand mainly due to high demand from China as it had high consumption of steel globally. India was believed to have a great potential for increase in demand and consequently in production and capacity expansion. It consumed about 59 million tones and its production of steel was only 53 million tones whereas China on the other hand produced 489 million tones and consumed 420 million tones which translated into per capita consumption of steel was around 6.5 times that of India. And experts and analyst believed that the Indian Steel Industry needed a quantum growth in the manufacturing capacity to cater to its own domestic demand.
Apart from above industry scenario one more feature of the global steel industry is its highly fragmented nature. The below chart list the top ten steel makers of the world.
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Rank 1 2 3 4 5 6 7 8 9 10
Company Name Arcelor-Mittal- Luxembourg Nippon Steel- Japan Posco South Korea JFE- Japan Tata-Corus- India Baosteel-China US Steel-USA Nucor- USA Riva- Italy Thyssen Krupp- Germany
Capacity- In Million Tonnes 109.7 32.0 30.5 29.9 28.0 22.7 19.3 18.4 17.5 16.5
Only 17% of the total world production in 2007 was contributed by the top 5 companies of the world. With such a fragmented industry that is in the mature stage of its life cycle, size and consequent increase in economies became a must to increase competitiveness and ensure survival and growth and thus it was very important for Tata to buy Corus both strategically and for survival and growth and de-risk the possibility of being taken over by the other giants and players in the sector.
Funding of the Corus-Tata Deal Total cash payment to shareholders of Corus at 608 pence per share working out at $ 12.9 billion and additional debts outstanding in Corus balance sheet which amounted to around $800 million which required being re-financed. Hence the total fund requirement was $13.7billion.
It adopted the strategy of multiple leveraging through a chain of holding and subsidiary companies. The purpose for doing so was to keep a minimum debt on the balance sheet of Tata steel as also to
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Minimize the equity dilution of Tata steel. The other reason was RBI restriction which was 200% know at 400% of net worth on the investment by an Indian company in joint venture or subsidiaries abroad in one financial year Mode Amt in US$BN Tata USMN Tata UK-Non-recourse Debt 6.14 Tata Asia- Bridge Loans 2.66 Tata Steel Equity & Debt 4.90 Internal accruals External Commercial borrowing Preferential issue to Tata sons Rights Equity issue Rights Convertible Pref Shares FC Equity linked Instrument Sub-Total Grand Total Steel Contribution
700 500 640 860 1,325 875 4,900
13.70
Rationale Behind the Acquisition Apart from Tata steel ambition of growth and globalization there was a urgent need for it to globalize and make it presence felt in the premier league of the top ten steel producing companies in the world. The Indian steel industry tiny by global standards was under threat of getting overcrowded with the Tata steel, Mittal, Posco planning green field capacities since the domestic demand for steel is unlikely to grow so dramatically as to absorb all the incremental capacities that might come up. India has been trying to increase exports to overcome the anticipated domestic situation of excess supply. This resulted in anti dumping actions and stringent policies taken by the developed countries like USA , EU and Canada, hence the compelling logic for Tata steel was to have production capacities in the export market and the Corus acquisition fits with the game plan.
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Also the sheer size of the new entity will give Tata the leverage and competitive power to battle it out with other multinational rivals and thwart a possible hostile takeover treat. As consolidation was the need of the hour for every enterprise for it survival and growth. Synergies between Tata and Corus would have been better as Tata being a low cost producer of steel and Corus had a large presence in value added segment and it has a strong distribution network in Europe. The other benefit was post acquisition Tata could supply semi-finished steel to Corus for converting into high value products in the finishing plant which are located in the European Markets. Another area was synergies in joint procurement, negotiation on raw material purchase price due to high production capacity and less vulnerability to the pressure on the prices of the end products; this will result in improving the bottom line of the merged entity. Tata steel could know adopt one of the two alternative strategies the first one which made more sense was that two would manufacture primary steel in India close to its iron ore deposit and ship the semi-finished product to Corus finishing plants in the developed markets and second to relocate some of the Corus capacity to India where expansion was anyway planned. Also Tata could now leverage upon Corus expertise in making high grade steel for supplies to growing Indian Automobile market. Tata could use the much better R&D capability that Corus had in developing and enhancing the product. The Flip Side Despite the potential benefits of the Corus deal, there were concern about the outcome and effects on Tata steel performance. It was felt that Corus EBITDA of 8 % was much lower than of Tata steel which was at 30% in the financial year 2006-07. The other concern was with regards to the valuation and funding of the deal. At 608 pence per share, Tata steel paid roughly about 69% premium to average mid-day stock price of Corus. EPS was at 37 pence per share. Considering this the price paid of 608 pence meant a P/E of 16.5
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which was much higher than industry average of 6 to 8. Corus Earned value or EV ended up being valued at approximately 7.7 times the EBITDA which was considered as an over valuation when compared to Arcelor-Mittal deal which was at 4.6% Another major concern between industries experts were that the acquisition will result in a significant dilution of equity in Tata steel, though there was hardly any debt taken on Tata steel balance sheet the combined entity had become highly leveraged due to the significant increase in debt in its capital structure. The debt that was financed through securitization of Corus assets and which was planned to be serviced by the cash flow generated by Corus there was potential danger of default if the business performance of Corus were to go down due to slow down in the global economy in near future. Other concern roaming around in the industry was with Corus deal Tata will no longer continue as the low cost steel producer in the world as it iron ore reserves in India which has a life of 50 years and a production capacity of 5.3million tones of steel will not be able to cater the 27 million production capacity of Tata-Corus. On the other hand Corus itself didnt have access to any iron or coal reserves. The expected bottom line through synergies of roughly about $300 million could not be achieved as per experts and it was vindicated by the results for the following year post acquisition where synergies achieved $76M as against $300M The Road Ahead Before the acquisition Tata steels major market was India, some part of Asia and pacific. India contributed roughly about 69% of it annual sales and on the other hand Corus sold it product mostly in the European market. Post acquisition the European market constitute to about 59% of the merged entitys total production. Its immediate plan was to conduct a joint synergy analysis and establish a time and plan for delivery. Since they had quite a few brownfield and Greenfield projects they EBITDA of 25% was also targeted, various teams were formed for manufacturing , steel making, marketing,
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logistics and procurement. These teams will provide reports to the top level management on synergies targets and deviation and action plan for corrective action. The deal gave Tata access to mature markets where they could go downstream much more than say in India or China and where quality of products and service is important. The new entity aimed at bringing new technology to Indian markets and develops new products to capture growth in India and across Asia. The below table show the Market spread before and after the acquisition.
Before the Acquisition Tata India 69% Asia 23% Row 8%
Corus Europe 49% UK 29% North America 10% Asia 9% Row 3%
After the Acquisition Tata-Corus Europe 37% UK 24% North America 22% Asia 8% Row 9%
Employee Issues:In Corus, There is a separate HR Department for each unit. Each unit has its own HRP which is different from the other units. In this case, it becomes difficult for the employee to get promoted to other high level position if applicable. They have to search for the appropriate HR department to get the details of the Positions if vacant. Also it leads to misunderstanding between the Leaders and the employees of different department as they do not know each other and the work done by them. Each department only knows the member of his own team. Whereas in Tata, It has a global HR department, where the details of each employee along with his leaders are stored and available for the whole organization. This helps the employee and the leaders to know each other well and can accommodate easily to the high level position the appropriate person if applicable.
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Indian companies often lack experience in international acquisitions with different corporate cultures, employment rules, etc. The Corus is identified for the foreseeable future and as an Anglo-Dutch company, where the management will be substantially the same. The trusteeship principle governing the way the group functions cast the Tatas in a rather unique light: capitalistic by definition but socialistic by character. India has an old tradition of philanthropy, passed on down the ages by kings, noblemen and rich merchants. Corus didnt make any pledges or commitments, but the deal wasnt predicated on closures, but instead, upon global opportunities. And that it was in the best interests of Corus employees to be globally competitive. Tata Steels executives must take into account that their European employees were beginning to feel uncertain about their fate in the newly created entity. Merger and acquisition experts recommended a light-handed integration between Tata Steel and Corus instead of engaging in a comprehensive organizational overhaul There was tremendous outpouring of nationalistic euphoria and economic patriotism in the Indian press after this deal. Merger Type:It is a clear case of cross border merger a highly leveraged merger. In this case, Tata Steel is an Indian based company which merges with the Corus Steel is Dutch based company. Cross-border mergers and acquisitions have gained tremendous popularity among Indian executives as a means to achieve growth and secure a global presence. According to David (2007), there are numerous seminars dealing with mergers and acquisitions where seasoned M&A executives offer advice on a number of topics ranging from government rules and regulations, pitfalls to avoid, and cultural issues impacting post-merger scenarios being.
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Secondly, it is a Horizontal Cogeneric merger which takes place between companies engaged in the same business activities for profit; i.e., manufacturing or distribution of same types of products or rendition of similar services. One of the classic instances of horizontal merger is the acquisition of Mobil by Exxon. Typically, horizontal mergers take place between business competitors within an industry, thereby leading to reduction in competition and increase in the scope for economies of scale and elimination of duplicate facilities. The main rationale behind horizontal mergers is achievement of economies of scale. However, horizontal mergers promote monopolistic trend in an industry by inhibiting competition.
Merger of ICICI With ICICI Bank

The Merger ICICI Bank was established in 1994 by March 2002 it had grown into a one-stop shop for all banking products offering various types of products to various corporate and house hold customer. It had Net income of Rs 204 crore in the year ended 31st March 2002. Assets and stock holders equity on the said date were Rs 40,480 crore and Rs 1810 crore respectively. The Industrial Credit and Investment Corporation of India Ltd were incorporated in 1955 and by 2002 had developed into a diversified financial services group. As on 30 March 2002 ICICI along with two of it subsidiaries ICICI Personal Financial services and ICICI Capital Services
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were amalgamated into ICICI Bank. The consideration paid was equity shares of ICICI Bank i.e one equity share of ICICI bank for every 2 equity share of ICICI. As of 30th March 2002 ICICI held approximately 10.14 crore shares of ICICI Bank amounting to 46% of the equity share capital of ICICI bank. Normally these shares should have been cancelled however the scheme of amalgamation had provided that these shares would be transferred to the ICICI Bank shares Trust that would hold these shares in a trust, exclusively for the benefit of ICICI and it successors which eventually means for the benefit of ICICI Bank only. These shares amounted to 16.5 percent of the post-merger equity share capital of the amalgamated company. In terms of the scheme of amalgamation the trustees had to dispose of these shares within 24 months of the amalgamation becoming effective and they were required to remit the proceeds to the amalgamated company. Thus with a smart move ICICI converted 16.5 % of its post-merger equity into treasury shares. However surprisingly these shares were sold by the trust in less than a year to institutional investors at Rs 130 per share. ICICI Bank scrip touched very high value both at BSE and NSE and one wonders why the trust sold the shares so hurriedly at such a low price. All necessary approvals were obtained from the companies of both the shareholders, High Court of Gujarat and Bombay High Court and finally by the RBI on 26th April 2002. The amalgamation was accounted in two different dates i.e. as per Indian accounting standards and as per US GAAP- This is because US GAAP requires that business combination should be accounted for in the period in which they are finally sanctioned. As per US GAAP in the accounting year ended 31 March 2002 as per the US GAAP, ICICI consolidate income was Rs 136 crore. Assets and shareholders equity as on the said date were Rs 74,850 crore and Rs 7,120 crore respectively. One can see the contrast easily. Against the asset base of over Rs 75,000 crore ICICI net income was only Rs 136 crore whereas, ICICI Bank had posted net income of Rs 204 crore on the asset strength of just over Rs 40,000 crore History of ICICI Bank
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In 1994, ICICI Bank was incorporated with 75% equity stake by ICICI and 25% by SCICI. Post Merger of SCICI ICICI became a wholly owned subsidiary of ICICI. However in terms of RBI banking license, ICICI was required to bring down its holding in ICICI Bank eventually to 40% with interim stage of 75%. This was achieved initially by a public offering in 1998 which brought down ICICI stake just below 75% and thereafter through American depository receipts of US$175Million; this brought the ICICI stake to approximately 62.2%. Post ICICI Bank acquisition of Bank of Madura it stake further reduced to 55.6 percent. It had to issue 2 shares of ICICI to 1 share of Bank of Madura. ICICI Bank generally claims that this acquisition gave ICICI Bank a larger balance sheet and extensive geographic reach. Thereafter ICICI sold 8% of ICICI banks equity stake to institutional investors thereby reducing its stake to 46.4% .This was transferred to ICICI bank share trust and later on sold by the trust to institutional investors at an average price of Rs 130 per share in September 2002. ICICI Bank had become a one stop for all banking products offering various types of banking products and services to a broad spectrum of corporate and household customers. ICICI Bank had adopted a strategy of leveraging on ICICI corporate and retail customer relationship for growing its retail business. It offered it corporate customers; payroll accounts schemes for their employees. It also took the opportunity of selling to ICICI retail bonds holders a variety of products such as bank accounts credit cards, demat accounts, retail loans etc. History of ICICI ICICI was formed in 1955 with an aim of creating a development financial institution its main objective then was to provide medium term and long term project finance to Indian industry. These activities dominated ICICI activities until the late 1980.However post liberalization ICICI diversified into other financial services such as venture capital funding-1988 asset management 1993, investment banking 1993, commercial banking 1994, brokering and marketing 1994, personal finance 1997, internet stock trading 1999, home finance 1999 and insurance 2000. This was done by setting up subsidiaries and group companies.
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Compulsions Behind the Merger The Various synergies that the merger of ICICI with ICICI Bank was expected to generate have been discussed later however the merger was essential for ICICI survival itself. ICICI primarily concentrated in project finance post liberalization not only ICICI but all the development financial institutions had a gala time as there were minimal competition from banks as they were not allowed to lend long term loans. Lending rates were high and being directed rates were more or less same by all DFIS. They also enjoyed cheaper government funding through refinance window, however liberalization changed the entire dynamics all the DFI had to compete with banks. Re-finance window was withdrawn and they had to borrow at market driven rates, further they could not mobilize one year deposits which banks could. Due to this reason cost of borrowing remained very high, The lack of DFI to lend at finer rates drove the borrowers to the banks and the DFI had to cater to more risky accounts. The profitability of DFI started sliding down, Second the delinquencies in loan portfolios started rising requiring them to make increased provisions hitting the bottom line further and add to woes the economic scenario between 1998 -2002 further worsened the situation and ICICI was no exception. In short while the loan portfolio by the end of fiscal 2001 was 2.8 times that of 1996 the provisioning and writes offs were 21.8 times that of 1996 By the end of March 2002 the situation on the front of impaired loans or non-performing assets worsened. Thus for its survival itself ICICI needed to merge with a banking institution with relatively low non-performing assets so that it could improve its profitability by access to lowcost deposit and also write off the diminution in the value of its assets in a creative manner. It had to make many write offs and provisions made against non-performing assets. Provision for diminution in the value of investments and provision against other assets. The value was staggering Rs 3,780/- crore. Writing off such a huge amount would have required a huge injection of fresh capital failing which it would have been spelt doom for ICICI. The merger
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gave a one time opportunity to creatively use purchase method of accounting to write off these amounts against the difference between the fair value of assets of ICICI taken over by ICICI bank and paid-up value of shares issued by the bank without creating even a flutter in the shareholders. Further using the loop hole in AS 14 ICICI Bank transferred the aggregate balances in capital reserve account, capital redemption reserve account, share premium account, general reserve account, profit and loss account and any other reserves of ICICI as reduced by the provision of other adjustments to general reserve account. This resulted in the ICICI Bank general reserve account enriching by Rs 3,210 crore. Other Rationale Behind the Merger Universal Banking It means a bank that engages itself in very wide range of activities and offers a very wide range of activities and offers a very wide range of products as compared to conventional banking institutes. Conventional banking institutes restrict to collecting short-term and long term deposits, lending short term and long term loans primarily to industrial borrowers and extending non-fund bases services such as LC, bank guarantee etc. On the other hand universal bank combines the function of a bank and an investment bank and offers besides banking products services mentioned before, products and services such as factoring, credit cards, housing finance, auto loans , education loan , mutual fund , merchant banking and investment banking services , insurance products etc. In todays world it is the universal bank that can grow much faster and also remain more profitable than the conventional banking institutes and stand-alone investment banks. The reasons for this economies of scale, effective resource utilization, use of cross functional expertise, ease of marketing by strong brand building, better customer retention through one stop shopping etc.
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Thus one of the main objectives of the merger of ICICI with ICICI Bank was to create a universal bank that can achieve the advantages of a universal bank mentioned above and grow exponentially. SIZE In any kind of business the SIZE matter and especially in banking size matters. Larger the size of the balance sheet, better the chances of higher growth as also better profitability. At the time of the merger the asset size of ICICI Bank on stand alone basis was only Rs 40,000/- crore or so. On the other hand, ICICI had an asset base of approximately Rs 75,000/- crore. Smaller size of its operations and balance sheet was coming in the way of ICICI Bank faster growth. The merger created a banking institution that had asset size of approximately 1, 00,000 crore, next only to SBI approximate size of 3, 00,000 crore at that time. ICICI Bank became and till now remains the largest privates sector bank and the second largest bank in India on overall basis. Capital Infusion through sale of its own shares Approximately 10.14 shares in ICICI Bank were transferred to ICICI Bank shares Trust and as per the scheme the trust was to hold these shares for the benefit of ICICI and its successors. The trust sold these share in the open market to institutional investors and this resulted in capital infusion of Rs 1300 crore and resulted in capital gain of Rs 1191 crore. It helped ICICI Bank to carry out window dressing of its performance during the year 2002-2003. In short creative accounting lead to ICICI Bank posting a net profit of Rs 1191 crore. Other Issues relating to the Merger Priority sector lending As per RBI every bank requires should extend 40% of its net bank credit to certain sectors such as agriculture, small scale industries that are called priority sectors. Prior to amalgamation ICICI was not required to do any priority sector lending. Post amalgamation it would have been
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practically impossible to reach the level of 40% hence the RBI stipulated that the merged entity should maintain an additional 10 % over the above requirement in the form of priority sector loans. This stipulation was to apply until such time as the aggregate of the priority sector advance of the merged entity reached a level of 40% of the total net bank credit of the merged entity. CRR/SLR Requirements Apart from the above not being a bank ICICI was not required to maintain any Cash reserve ratio CRR or statutory liquid ratio- SLR on its time demand and time deposits. The Merger made it necessary to mobilize funds to the tune of Rs 15000 to Rs 18000 crore to meet the CRR & SLR requirements of ICICI borrowings In short one may conclude that the merger which was driven by the compulsion of the survival of ICICI aided by creative accounting, led to the creation of a strong universal banking institution. Who Says accountants dont contribute to business?
Key Terminologies
Merger Consolidation Acquisition Divestiture Demerger Carve-out Joint Venture Reduction Capital Buyback
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BIBLIOGRAPHY
Referred Prasad.G.Godboles book on Mergers, Acquisitions and Corporate Restructuring Forbes Magazine International M&A Joint Ventures & Beyond by David J. BenDaniel , Arthur H. RosenBloom, James J . Hanks Jr.
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