Corporate restructuring

Mergers & Amalgamations and Take overs

Term debt restructuring Divestments

Demerger
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Corporate Reorganisations
To create long term holding structures Cohesiveness in group structure and corporate objectives Faster growth rate then an organic growth rate To enter into a new market or grow beyond a saturated market To capture forward and backward linkages in the value chain To attain control on a larger fund / manufacturing base / Resources / Intellectual property rights / patents etc. To attain or better utilise tax covers To facilitate distribution of assets and family settlements To exit non-core business Valuation of business

Forms of Corporate Restructuring

Expansions - Mergers & Acquisitions - Tender offers / Take over - JVs / Asset acquisition Sell-offs - Spin offs - Divestitures / Demergers Corporate Control - Share buybacks - Defence mechanisms Changes in Ownership structure - Swaps - Going private

Restructuring - key issues

COMMERCIAL Scales of Operation Identify markets Prioritise resources allocated FINANCIAL

LEGAL Tax,Regulatory Direct / Indirect Cost of restructuring Operational

Exsisting group networth Promoter funding / resources Managerial bandwidth Future funding / internal reqt. Stratergic alliances Exsisting level of expertise
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Dilution Management
Rights Renounciation Preferential allotment of shares to Promoters Private placement to Promoter group Issue of convertibles Creeping acquisition Share Buyback Shares with differential rights Delisting of shares
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Merger
Defined as the fusion or absorbtion of one Co into another. It is an arrangement whereby assets of two or more companies become vested in , or under the control of one Co. One of the two existing Co merges its identity into another existing Co or one or more existing Co may form another Co. Allotment of shares will be done in accordance with the share exchange ratio incorporated in the scheme of merger.

Amalgamation
Amalgamation is the process by which two or more companies are joined together to form a new identity It is an arrangement to bring assets of two companies under the control of one which may or may not be one of the original companies. For the purpose s of companies act Mergers & Amalgamations are synonymous. The former loses its entity and is dissolved without winding up.

Rationale
Low promoter holdings Market capitalisation lower than book value Low book values vis-a vis high replacement value Under performing businesses Sectoral growth potential Swift addition of facilities , personnel & processes Tax efficiency / savings Diversification Access to inputs Defensive considerations
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Operating or Financial Synergy

Greater pricing power Combination of functional strengths Higher growth in emerging markets Debt capacity increase Tax benefits Value of control Reduced risk resulting in improvement of credit rating
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Mergers
Types of merger :

1. Horizontal merger : Merger of companies in same business segments.

2. Vertical mergers : Merger of companies which would result in either backward/forward integration. 3. Conglomerate merger : Unrelated business 4. Concentric merger
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Structuring an M & A transaction

Evaluate options Finalise strategy Due diligence Valuation / Negotiations Preparation of a scheme of merger / Amalgamation Board meeting / Application to High court Notices and General body meeting Approval by court
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Steps in a Valuation

Calculate NOPAT and invested capital Calculate value drivers Develop an integrated historical perspective Analyze financial health
Understand strategic position Develop performance scenarios Forecast individual line items Check overall forecast for reasonableness Develop target market value weights Estimate cost of non equity financing Estimate cost of equity financing

Select appropriate technique Select forecast horizon Estimate the parameters Discount continuing value to present

Calculate and test results Interpret results within decision context

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Methods of Valuation
Asset Based Market Based Earning based

Realisable Price/Earning Discounted Value Cash Flow Price /Book Adjusted NAV Value Earnings Replacement Current market capitalisation cost price Comparable multiples

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Balance sheet approach

Based on NAV & book value Establishes minimum / floor price at which seller may like to sell Method pertinent when value of intangibles is not significant & business is recently set up Takes into account amount historically spent & earned and does not consider future earnings potential and hence is seldomly used for a going concern

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Transaction multiples with comparables

Select comparable firms with operational and structural similarities Value paid for similar transactions in the industry with benchmarks EBITDA capitalised to get appropriate value Sales / EPS / BV multiples EV / EBITDA multiple Conversion of Equity to Debt will reduce EV thereby improving the EV /EBIDTA multiple
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Discounted Free cash flows

Forecast free cash flows for the future
Establish discounting factor Discount free cash flows PV of future free cash flows would be the capitalised value of equity

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Enterprise valuation
Using free cash flow discounting approach determine value of equity
Determine value of debt outstanding on date

Enterprise value = Equity valuation + Value of debt EV / EBITDA Multiple measures the degree of dispersion in an inter firm analysis.( Lower the ratio the better )
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Ideal methodology for

Businesses which are a going concern
Businesses which posses intangibles such as brand , technology,market leadership,goodwill,marketing & distribution channels etc. Substantial undisclosed assets

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It takes into account.

All available free cash flows to stake holders and it takes into consideration the wacoc and associated risk factors. Value of core assets gets captured while non-core assets need to be added separately Captures incremental capital cost for balancing / modernisation / expansion with associated benefits. Intangibles like market share, technological superiority etc gets factored in while in the other methods of valuation they are ignored.

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Shortcomings
The estimation of risk adjusted discount rate for base projects are difficult to estimate.

The cost of equity is a difficult proposition even with the use of CAPM as the Beta used to value is an approximation at best.
The WACC for the company changes with time. Estimation of WACC, which remains valid in the future, is difficult. Many projects under taken by the company may have embedded real options. The value of equity arrived at after the DCF process does not take into consideration the default option exercisable by the shareholders

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Asset based Valuation

Fair market value Realiseable value Adjusted book value Replacement cost

Depreciated replacement cost (New price-WDV )

Ideal methodology in the event of liquidation / closure
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Impact of key variables on value creation Example: Acquistion of two Thai telecommunications companies Worst case Expected Case Net value to buyer

Best case

100

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-50 Economic outlook GDP grows more slowly than expected in the next 5 years(0-1% in reals terms) Demand is at low end of forecast Regulation Operational consolidation prohibited Many new licences issued Royalties to regulatory bodies remain Level of Many new entrants to the Competion market market shares fall after 2-3 years Revenues per subscriber fall faster than expected GDP grows as expected in the next 5 years(3-4% in real terms) Demand meets base case forecast Operational consolidation allowed New licences limited Royalties to rgulatory bodies remain Few new entrants to the market Market shares rise gradually, then stabilize Revenues per subscriber falls slowly GDP grows faster than expected in the next 5 years (5-7% in real terms. Demand is at hig end of forecast Operational consolidation allowed No new licences issued Royalties to regulatory bodies diminish No new entrants to the market Market shares rise steadily over the next few years Revenues per subscriber fall after 2-3 years

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Exchange Ratios
EPS based firms could follow different accounting policies

Book value based historical value of assets may not account for current market realizations
NAV based will have to necessitate revaluation of assets Market price based average price over a period of time. only applicable if both the firms are listed It is based on the discounted value of future earnings incorporating risk
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Exchange ratios
Capitalisation rate based used when firms are not listed or frequently traded uses EPS as a base with an appropriate PE multiple has element of judgment attached to it.

Composite based frequently used methodology combination of above methods with weights for each multiple regression model weights can be highly subjective
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Bid Range
Valuation range - Return criteria - Other bidders

- Vision of future value

- Other acquisition opportunities - Defensive considerations - Financing constrainst - Buyers long-term objectives - Dilution
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Transaction structure
Upfront 100% Exit
Phased exit Continual holding with minority rights Continual holding with majority rights
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Shareholders agreement
Earn out mechanism for loss of value ROFR with tag / drag along Asset stripping White knight structuring of powers / rights / obligations Board representation Voting arrangements / management control Estoppel powers Affirmative rights for specific items Put / call options between inter-se holders Post closing adjustments Raising of Capital
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Value drivers
Effects of regulatory framework Market leadership Synergies in capacity imbalances Business fit Brand acquisition / withdrawal Backward / forward integration resulting in integration of operations Prevent shake out effect Barrier to entry High replacement cost
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Value Discharge
Earn out mechanism Profit from current year other revenues Cash Debt discharge Liability guarantee take over Issuance of shares of new company Asset sale Sale of Brands

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Valuation of intangibles
Brands including brands of goods and corporate names Publishing rights
Intellectual property patents, copyrights, trademarks Licenses distribution rights, franchises

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Special valuation situations

Valuation of cyclical firms

Valuation of firms in financial distress

Valuation of thinly traded/illiquid shares

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Legal & Regulatory framework for Mergers, Acquisitions and Takeovers

- Companies act 1956 & 2000
- FEMA

- Income tax act, 1961

- SEBI guidelines

- FIPB guidelines

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M&A under Companies act

Provisions contained under sections 390 to 396A contain the following : 1. There should be a scheme of arrangement 2. Holding a meeting of shareholders in terms of direction of the high court. 3. Scheme to be approved by 75% in value of creditors and shareholders. 4. Application to Court for scantion of scheme.Courts order binding on all but appeal able in a superior court.

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Scheme of Amalgamation
1. Effective date.

2.
3. 4. 5. 6. 7. 8.

Capital structure of the transferor & transferee co.

Share exchange ratio Transfer of undertaking and liabilities and continuance of legal proceedings by the transferee co. Transfer of contracts , services of employees Allotment date of transferee co shares Dissolution of transferor co. Conditions subject to which the scheme is to take effect.

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Statutory Approvals
Approval of board of directors Approval of shareholders and creditors Approval of Financial institutions Approval of Land owners Approval of the High court Approval of RBI Notice to Central Government

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SEBI Take over code

Acquirer must disclose to Company / stock exchange upon acquisition of 5% of shares. Public offer mandatory once acquirer acquires more than 15% of the companys shares Public offer at 6 months average or 2 weeks which ever is higher.

Minimum 20% of the voting capital must be acquired from the public
Upward revisions in price /quantity can be made upto 7 days prior to the closure of the offer. In a PSU disinvestments a subsequent Put / call option will not trigger a public offer if it is a part of SHA.
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SEBI Take over code

The date of opening of the offer shall be within 16 days of the public announcement and shall remain open for a period of 30 days. In a PSU disinvestments public offer will have to be at the offer price by SP to Govt. or last 6 months weekly average which ever is higher. Counter offer within 21 days Persons acting in Concert broad definition Maintaining of Escrow cover and security deposits with the Merchant bankers Creeping acquisition upto 5% per annum will not trigger take over code from 15% to 75%.
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Taxation Aspects
Benefit u/s 72 A of carry forward & set off of accumulated loss and unabsorbed depreciation allowed in the event the transferee co holds for a minimum period of 5 years 75% of the value of the assets and continues the business of the amalgamated co also for a period of 5 years. Capital gains tax not applicable since it does not involve sale , relinquishment or exchange.

Amortisation of preliminary expenses allowed

Tax aspects on slump sale
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Asset purchase: Pros

- Enables acquisition of identified assets only - Enables purchase of depreciable assets at high value, therby getting future tax shields

- Enables keeping off undesirable liabilities

- Need not absorb all employees

- Less due diligence

- Buyer can create a suitable SPV, does not have to put up with shareholders of the selling company.
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Asset purchase: cons

- Tax inefficient for the seller
- Capital gains long term on non depreciable assets, could be short term on depreciable assets -Further taxation, when the proceeds are distributed to shareholders as dividends (10% distribution tax)

- High transaction costs - Stamp duty (conveyance) - Sales tax, in certain cases - Shareholder and lender consent required
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Share purchase: pros

- Immediate acquisition of an operating business - Tax efficient for the seller (long term capital gains with indexation)

- Lowest transaction costs (0.5% stamp duty, no sales tax)

- Quicker in terms of third party approvals - Consideration flows to shareholders directly

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Share Purchase: cons

- Buyer inherits all liabilities (disclosed and contingent) - Buyer inherits all manpower - A stricter and detailed due diligence - In case of purchase of shares in a listed entity, takeover code will get triggered in case of acquisition. - Buyer has to put up with other shareholders of the company

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Funding corporate acquisitions

Direct balance sheet financing by acquirer
Thru a SPV with cross holdings

Consortium of firms acting in concert as acquirers

Combination of all cash / all stock / hybrid Objectives of share holders of acquiring firm differ from those of acquired firm
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Funding corporate acquisitions equity stock financing route

Acquirer issues stock of his firm Cash outflows are prevented Ideal for companies in the sunrise industry or for firms with high growth prospects who have yet to generate cash Dilution of EPS and shareholding of the existing shareholders will take place As compared to debt tangible, cost being dividend does not increase the fixed cost Synergetic benefits must pay for enhanced equity servicing as well as the PE multiple of the merged entities must not fall which could signify value destruction Risks as well as value from synergies will be shared by the share holders of both the firms
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Equity stock financing

In the event acquiring firms shares are perceivably under valued then it may be in efficient to the acquirer firm as its cost of acquisition will increase

Will have an impact on the market perception of the acquirer firm and could result in destruction of value as compared to a all cash transaction

Provisions of NBFC not applicable for SPVs created for acquiring PSU shares under the Disinvestment policy of GOI.

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Cash financing
Entail heavy out flow of cash upfront ( PSU divestment ) Synergetic benefit must pay for interest cost. Long term / medium term instruments Impact of dilution of earnings due to interest burden Impact on credit rating / debt appetite of acquirer Use of warrants / debentures / convertible bonds Sale of assets of not related business segment In event of excessive liquidity short term sources could be deployed Leveraging group companies through a SPV May be in efficient to the share holders of the acquired firm due to tax liabilities
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Transaction Strategy
Identify and review stakeholder objectives

Structure a controlled and competitive process

Devise and implement the sale strategy

Timing and Confidentiality Value expectations Management control and other strategic considerations Structuring considerations in terms of tax, legal and regulatory issues Strategic fit with Company Employee concerns

Review list of potential partners Maintain information control, process and timing Create and maintain competitive tension Minimise disruption of business operations

Release of Advertisement Approach potential partners with limited information and solicit preliminary interest Identify further shortlist required, to proceed with comprehensive due diligence, solicit binding bids, negotiate and select successful bidder

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Transaction Methodology
PHASE 1 PHASE 2 PHASE 3 PHASE 4 PHASE 5

Define Objectives Transaction Structuring Valuation Documentation Others Release of Advertisement

Preliminary interest by potential partners Review list of potential partners Circulate Confidentiality Undertaking and Information Memorandum

Circulate due diligence visit rules Data room and site visits Circulate Draft Share Purchase Agreement Pre-bid conference

Receipt and evaluation of binding bids Recommendation

Agreement Signing Statutory Approvals

Winning bidder selection

Closure

4 weeks

4 weeks

6 weeks

4 weeks

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Transaction Methodology
Phase 1
Definition Transaction structuring Valuation Documentation Others

Restructuring, if required Objectives Maximise proceeds

Size of stake to be offered Fund requirements Management control / other strategic issues Employee issues Regulatory issues

Discussions with management and info collection Business valuation of companies Sensitivity analysis for transaction structuring Assess optimal capital structure

Attract funds/technology
Mktg./Ops expertise Transparency Employee Welfare

Finalise Investment Profile Confidentiality Undertaking Information Memorandum Draft Share Purchase Agr. Assist in Agreements Regulatory

Prepare Data Room Finalise technical and financial bid evaluation criteria Draft rules for site visits and due diligence

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Transaction Methodology
Phase 3 Phase 4
Marketing
Shortlisting Due-diligence

Phase 5

Selection

Signing

Release advertisement Follow up with calls/mailers and one-to-one meetings Receive preliminary bids

Shortlist, if required Circulate Confidentiality Undertaking Circulate IMs and due diligence rules on receipt of Confidentiality Undertaking

Co-ordinate due diligence Manage data room, site visits Circulate draft Share Purchase Agreement Pre-bid conference & supply of addl. information

Finalise Share Purchase Agreement Co-ordinate and receive final bids Evaluate bids Assist in negotiations Choose the partner(s)

Complete legal formalities such as obtain approvals and sign Agreements Transfer of funds Issue and / or transfer shares to partner(s)

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Price Earning Ratio Valuation Comparison with Management control

Sale of Shares

Strategic Disinvestment

1. 2. 3. 4. 5.

1991-99 IOC = BPCL = HPCL = GAIL = VSNL = (in monopoly days)

4.9 5.7 5.9 4.4 6.0

2000 onwards 1. BALCO = 19 2. CMC = 12 3. HTL = 37 4. MFIL = very high * 5. LJMC = - do 6. PPL = - do 7. JESSOP = - do 8. IBP = 63 9. VSNL = 11 ** 10. HZL = 26 11. MARUTI = 89 12. IPCL = 58

* As earning per share was negative. ** inclusive of income from dividend etc. (after the end of monopoly) 51