Q.1 Give the meaning of merger and acquisition.

What are the key motives behind the merger and acquisitions? Ans. Mergers or amalgamation:- Merger is defined as a combination where two or more than two companies combine into one company. In this process one company survives and others lose their corporate existence. The survivor acquires assets as well as Liabilities of the merged company or companies. Merger is also defined as Amalgamation, especially in Indian law. For example section 2 (1A) of the Income tax Act, 1961 defines amalgamation as the merger of one or more companies (called amalgamating company or companies) with another company (called amalgamated company) or the merger of two or more companies to form a new company in such a way that all assets and liabilities of the amalgamated company or companies become assets and liabilities of the amalgamating company and shareholders holding not less than nine-tenths in the value of the shares in the amalgamating company or companies become shareholders of the amalgamated company. Merger or Amalgamation may take two forms i.e. Merger through Absorption and Merger through Consolidation. Acquisitions:- The term acquisition refers to the acquisition of assets by one company form another company. In an acquisition, both companies may continue to exist. We will hereafter use the word mergers & acquisitions interchangeably and will refer to these as a business transaction where one company acquires another company. An acquisition, also known as a takeover, is the buying of one company (the target) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the targets board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. Sometimes, however, a smaller firm will acquire management control of a larger or longer established company and keep its name for the combined entity. This is known as a reverse takeover. Motives behind the mergers and acquisitionsThere are a number of possible motivations that may result in a merger or acquisition. One of the most oft cited reasons is to achieve economies of scale. Economies of scale may be defined as a lowering of the average cost to produce one unit due to an increase in the total amount of production. The idea is that the larger firm resulting from the merger can produce more cheaply than the previously separate firms. Plausible reasons- The most plausible reasons:Strategic benefits:- If a firm has decided to enter or expand in a particular industry, acquisition of a firm engaged in that industry, rather than dependence on internal expansion, may offer several strategic advantages like. As a pre-emptive move it can prevent a competitor from establishing a similar position in that industry. It offers a special timing advantage because the merger alternative enables a firm to leap frog several stages in the process of expansion. It may entail less risk and even less cost.

In a saturated market, simultaneous expansion and replacement makes more sense than creation of additional capacity through internal expansion. Economies of vertical integration:- When companies engaged at different stages of production or value chain merge, economies of vertical integration may be realized. For example, the merger of a company engaged in oil exploration and production with a company engaged in refining and marketing may improve coordination and control. Complementary resources:- It two firms have complementary resources, it may make sense for them to merge. For example, a small firm with an innovative product may need the engineering capability and marketing reach of a big firm. With the merger of the two firms it may be possible to successfully manufacture and market the innovative product. Thus, the two firms thanks to their complementary resources are worth more together than they are separately. Tax shield:- When a firm with accumulated losses and/or unabsorbed depreciation merges with a profit making firm, tax shields are utilized better. The firm with accumulated losses and/or unabsorbed depreciation may not be able to drive tax advantages for long time. Utilization of surplus funds:- A firm in a mature industry may generate a lot of cash but may not have opportunities for profitable investment. Such a firm ought to distribute generous dividends and even buy back its shares, to the same is possible. Managerial effectiveness:- One of the potential gains of merger is an increase in managerial effectiveness. This may occur if the existing management team, which is performing poorly, is replaced by a more effective management.

Q.2

Explain the different types of synergy.

Ans. Synergy is the additional value that is generated by the combination of two or more than two firms creating opportunities that would not be available to the firms independently. There are two main types of synergy: 1. Operating synergy 2. Financial synergy Operating Synergy: Operating synergies are those synergies that allow firms to increase their operating income, increase growth or both. We would categorize operating synergies into four types: 1. Economies of scale: It may arise from the merger, allowing the combined firm to become more cost-efficient and profitable. Economics of scales can be seen in mergers of firms in the same business. For example : Two banks combining together to create a larger bank. Merger of HDFC bank with Centurian bank of Punjab can be taken as an example of cost reducing operating synergy. Both the banks after combination can expect to cut costs considerably on account of sharing of their resources and thus avoiding duplication of facilities available.

2. Greater pricing power: It from reduced competition and higher market share, which should result in higher margins and operating income. This synergy is also more likely to show up in mergers of firms which are in the same line of business and should be more likely to yield benefits when there are relatively few firms in the business. When there are more firms in the industry ability of firms to exercise relatively higher price reduces and in such a situation the synergy does not seem to work as desired. An example of limiting competition to increase pricing power is the acquisition of universal luggage by Blow Plast. The two companies were in the same line of business and were in direct competition with each other leading to a severe price war and increased marketing costs. After the acquisition blow past acquired a strong hold on the market and operated under near monopoly situation. Another example is the acquisition of Tomco by Hindustan Lever. 3. Combination of different functional strengths: Combination of different functional strengths may enhance the revenues of each merger partner thereby enabling each company to expand its revenues. The phenomenon can be understood in cases where one company with an established brand name lends its reputation to a company with upcoming product line or a company. A company with strong distribution network merges with a firm that has products of great potential but is unable to reach the market before its competitors can do so. In other words the two companies should get the advantage of the combination of their complimentary functional strengths. 4. Higher growth: Higher growth in new or existing markets, arising from the combination of the two firms. This would be case when a US consumer products firm acquires an emerging market firm, with an established distribution network and brand name recognition, and uses these strengths to increase sales of its products. Operating synergies can affect margins and growth, and through these the value of the firms involved in the merger or acquisition. Synergy results from complementary activities. This can be understood with the following example. Example: Consider a situation where there are two firms A and B. Firm A is having substantial amount of financial resources (having enough surplus cash that can be invested somewhere) while firm B is having profitable investment opportunities ( but is lacking surplus cash). If A and B combine with each other both can utilize each other strengths, for example here A can invest its resource in the opportunities available to B. note that this can happen only when the two firms are combined with each other or in other words they must act in a way as if they are one. Financial Synergy: With financial synergies, the benefits can take the form of either higher cash flows or a lower cost of capital (discount rate) or both. Financial synergies can be present in the following cases: 1. A combination of a firm with excess cash, or cash slack, (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm. The increase in value comes from the projects that were taken with the excess cash that otherwise would not have been taken. This synergy is likely to show up most often when large firms acquire smaller firms, or when publicly traded firms acquire private businesses.

2. Debt capacity can increase, because when two firms combine, their earnings and cash flows may become more stable and predictable. This, in turn, allows them to borrow more than they could have as individual entities, which creates a tax benefit for the combined firm. This tax benefit can either be shown as higher cash flows, or take the form of a lower cost of capital for the combined firm. 3. Tax benefits can arise either from the acquisition taking advantage of tax laws or from the use of net operating losses to shelter income. Thus, a profitable firm that acquires a money-losing firm may be able to use the net operating losses of the latter to reduce its tax burden. Alternatively, a firm that is able to increase its depreciation charges after an acquisition will save in taxes, and increase its value. Clearly, there is potential for synergy in many mergers. The more important issues are whether that synergy can be valued and, if so, how to value it. This result has to be interpreted with caution, however, since the increase in the value of the combined firm after a merger is also consistent with a number of other hypotheses explaining acquisitions, including under valuation and a change in corporate control. It is thus a weak test of the synergy hypothesis. The existence of synergy generally implies that the combined firm will become more profitable or grow at a faster rate after the merger than will the firms operating separately. A stronger test of synergy is to evaluate whether merged firms improve their performance (profitability and growth) relative to their competitors, after takeovers. On this test, as we show later in this chapter, many mergers fail.

Q.4 Explain the following: (a). (b). (c). (d). (e). Ans. (a). Spin-off: In a spin-off new legal entity is created. Once again, new shares are issued, but here they are distributed to stockholders on a pro rata basis. As a result of the proportional distribution of shares, the stockholder base in the new company is the same as that of the old company. Although the stockholders are initially the same the spun-off firm has its own management and is run as a separate company. (b). Sell-off: Selling a part or all the firm by any one of means: sale, liquidation, spin-off & so on or General term for divestiture of part/all of a firm by any one of a no. of means: sale, liquidation, spin-off and so on. Partial Sell-off Spin-off Sell-off Equity carve out LBO ESOP

A partial sell-off/slump sale, involves the sale of a business unit or plant of one firm to another. It is the mirror image of a purchase of a business unit or plant. From the sellers perspective, it is a form of contraction; from the buyers point of view it is a form of expansion.

(c). Equity carve out: An equity carve-out is a variation of a divestiture that involves the sale of an equity interest in a subsidiary to outsiders. The sale may not necessarily leave the company in control of the subsidiary. The new equity gives the investors shares of ownership in the portion of the selling company that is being divested. In an equity carve-out, a new legal entity is created with a stockholder base that may be different from that of the parent selling company. The divested company has a different management team and is run as a separate firm. This mode of restructuring creates a new publicly traded company with partial or complete autonomy from the parent firm. Equity carve-out became a popular financing technique in the late 1980s. (d). LBO(Leveraged Buy Outs): A buyout is a transaction in which a person, group of people, or organization buys a company or a controlling share in the stock of a company. Buyouts great and small occurs all over the world on a daily basis. Buyouts can also be negotiated with people or companies on the outside. A company which makes widgets might decide to buy a company which makes thingamabobs in order to expand its operation, using a establishing company as a base rather than trying to start from scratch. In a leveraged buyout, the company is purchased primarily with borrowed funds. In fact, as much of 90% of the purchase price can be borrowed. This can be a risky decision, as the assets of the company are usually used as collateral, and if the company fails to perform, it can go bankrupt because the people involved in the buyout will not able to service their debt. (e). ESOP(Employee Stock Ownership Plans): An Employee Stock Option is a type of defined contribution benefit plan that buys and hold stock. ESOP is a qualified, defined contribute on, employee benefit plan designed to invest primarily in the stock of the sponsoring employer. Employee Stock options are qualified in the sense that the ESOPs sponsoring company, the selling shareholder and participants receive various tax benefits. With an ESOP, employee never buy or hold the stock directly. Features: Employee Stock Ownership Plan(ESOP) is an employee benefit plan. The scheme provides employee the ownership of stocks in the company. It is one of the profit sharing plans. Employers have the benefit to use the ESOPs as a tool to fetch loans from a financial institute. It also provides for tax benefits to the employers.

Q.5 Explain the meaning of joint Venture. What area the characteristics of joint ventures? Ans. Meaning of Joint Venture:- The term joint venture is an umbrella term which describes the commercial arrangement between two or more economically independent entities. In practice, the legal form of a joint venture is likely to be determined by a number of factors including the nature and size of enterprise, the anticipated length of the venture, the identity and location of the ventures and the commercial and financial objectives of the participants. Characteristics of Joint VentureSome of the key features of a JV are: JVs are typically not a passive investment. Generally the parties need to contribute skills as well as money. JVs are typically for a single business, development or project rather than a long term relationship between the co-ventures. JVs usually are not the major activity of the parties concerned. If theyre individuals theyll have day jobs. In the business work theyll have a core business to which the JV is an adjunct typically. The JV is a collaborative extension of their commercial activities. The association between the participants is almost invariable regulated by a written agreement called a Joint Venture Agreement (JVA). These characteristics will be present in all joint venture relationships regardless of the structure the parties adopt.

Q.6 What is share warrant and convertible debentures? Calculate fully diluted EPS. Ans. Presume the following data for an hypothetical target company: Outstanding shares Outstanding warrants Warrant exercise period Entitlement to holders 10,00,000 2,00,000 2 years 1 share of Rs. 2

Earnings after Tax Corporation Tax Closing price stock on opening of the year= Rs. 25.00

Rs. 3, 00, 000 45% 121/2 % convertible

Calculations of EPS: Earnings Add: Return form investment of proceeds from Warrants=(2,00,000 Rs. 2) Less: Tax

Rs. 3,00,000

= Rs. 20,000

20,000 x 0.45 = Rs. 9,000 11,000 3,11,000

Fully diluted EPS =3,11,000 = Rs. 0.2592. Earnings per share before exercise or warrants was Rs. Rs. 0.30 which has now diluted by 0.3 (-) 0.259 = 0.44 or 4% (10,00,000 + 2,00,000)