Corporate Restructuring Module - 1 Introduction With Indian corporate houses showing sustained growth over the last decade, many have shown an interest in growing globally by choosing to acquire or merge with other companies outside India. One such example would be the acquisition of Britain’s Corus by Tata an Indian conglomerate by way of a leveraged buy-out. The Tatas also acquired Jaguar and Land Rover in a significant cross border transaction. Whereas both transactions involved the acquisition of assets in a foreign jurisdiction, both transactions were also governed by Indian domestic law. Whether a merger or an acquisition is that of an Indian entity or it is an Indian entity acquiring a foreign entity, such a transaction would be governed by Indian domestic law. In the sections which follow, we touch up on different laws with a view to educate the reader of the broader areas of law which would be of significance. Mergers and acquisitions are methods by which distinct businesses may combine. Joint ventures are another way for two businesses to work together to achieve growth as partners in progress, though a joint venture is more of a contractual arrangement between two or more businesses. Corporate Restructuring Classifications A. MERGERS AND AMALGAMATIONS. The term ‘merger’ is not defined under the Companies Act, 1956 (the ‘Companies Act’), the Income Tax Act, 1961 (the ‘ITA’) or any other Indian law. Simply put, a merger is a combination of two or more distinct entities into one; the desired effect being not just the accumulation of assets and liabilities of the distinct entities, but to achieve several other benefits such as, economies of scale, acquisition of cutting edge technologies, obtaining access into sectors / markets with established
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Corporate Restructuring
Module - 1
Introduction
With Indian corporate houses showing sustained growth over the last decade, many have shown an interest in
growing globally by choosing to acquire or merge with other companies outside India. One such example
would be the acquisition of Britain’s Corus by Tata an Indian conglomerate by way of a leveraged buy-out.
The Tatas also acquired Jaguar and Land Rover in a significant cross border transaction. Whereas both
transactions involved the acquisition of assets in a foreign jurisdiction, both transactions were also governed
by Indian domestic law.
Whether a merger or an acquisition is that of an Indian entity or it is an Indian entity acquiring a foreign
entity, such a transaction would be governed by Indian domestic law. In the sections which follow, we touch
up on different laws with a view to educate the reader of the broader areas of law which would be of
significance. Mergers and acquisitions are methods by which distinct businesses may combine. Joint ventures
are another way for two businesses to work together to achieve growth as partners in progress, though a joint
venture is more of a contractual arrangement between two or more businesses.
Corporate Restructuring Classifications
A. MERGERS AND AMALGAMATIONS.
The term ‘merger’ is not defined under the Companies Act, 1956 (the ‘Companies Act’), the Income Tax Act,
1961 (the ‘ITA’) or any other Indian law. Simply put, a merger is a combination of two or more distinct
entities into one; the desired effect being not just the accumulation of assets and liabilities of the distinct
entities, but to achieve several other benefits such as, economies of scale, acquisition of cutting edge
technologies, obtaining access into sectors / markets with established players etc. Generally, in a merger, the
merging entities would cease to be in existence and would merge into a single surviving entity.
Very often, the two expressions "merger" and "amalgamation" are used synonymously. But there is, in fact, a
difference. Merger generally refers to a circumstance in which the assets and liabilities of a company
(merging company) are vested in another company (the merged company). The merging entity loses its
identity and its shareholders become shareholders of the merged company. On the other hand, an
amalgamation is an arrangement, whereby the assets and liabilities of two or more companies (amalgamating
companies) become vested in another company (the amalgamated company). The amalgamating companies
all lose their identity and emerge as the amalgamated company; though in certain transaction structures the
amalgamated company may or may not be one of the original companies. The shareholders of the
amalgamating companies become shareholders of the amalgamated company. While the Companies Act does
not define a merger or amalgamation, Sections 390 to 394 of the Companies Act deal with the analogous
concept of schemes of arrangement or compromise between a company, it shareholders and/or its creditors. A
merger of a company ‘A’ with another company ‘B’ would involve two schemes of arrangements, one
between A and its shareholders and the other between B and its shareholders.
Mergers may be of several types, depending on the requirements of the merging entities:
Horizontal Mergers: Also referred to as a ‘horizontal integration’, this kind of merger takes place between
entities engaged in competing businesses which are at the same stage of the industrial process.2 A horizontal
merger takes a company a step closer towards monopoly by eliminating a competitor and establishing a
stronger presence in the market. The other benefits of this form of merger are the advantages of economies of
scale and economies of scope.
Vertical Mergers: Vertical mergers refer to the combination of two entities at different stages of the industrial
or production process. For example, the merger of a company engaged in the construction business with a
company engaged in production of brick or steel would lead to vertical integration. Companies stand to gain
on account of lower transaction costs and synchronization of demand and supply. Moreover, vertical
integration helps a company move towards greater independence and self-sufficiency. The downside of a
vertical merger involves large investments in technology in order to compete effectively.
Congeneric Mergers:These are mergers between entities engaged in the same general industry and somewhat
interrelated, but having no common customer-supplier relationship. A company uses this type of merger in
order to use the resulting ability to use the same sales and distribution channels to reach the customers of both
businesses.
Conglomerate Mergers: A conglomerate merger is a merger between two entities in unrelated industries. The
principal reason for a conglomerate merger is utilization of financial resources, enlargement of debt capacity,
and increase in the value of outstanding shares by increased leverage and earnings per share, and by lowering
the average cost of capital.4 A merger with a diverse business also helps the company to foray into varied
businesses without having to incur large start-up costs normally associated with a new business.
Cash Merger: In a typical merger, the merged entity combines the assets of the two companies and grants the
shareholders of each original company shares in the new company based on the relative valuations of the two
original companies. However, in the case of a ‘cash merger’, also known as a ‘cash-out merger’, the
shareholders of one entity receive cash in place of shares in the merged entity. This is a common practice in
cases where the shareholders of one of the merging entities do not want to be a part of the merged entity.
Triangular Merger: A triangular merger is often resorted to for regulatory and tax reasons. As the name
suggests, it is a tripartite arrangement in which the target merges with a subsidiary of the acquirer. Based on
which entity is the survivor after such merger, a triangular merger may be forward (when the target merges
into the subsidiary and the subsidiary survives), or reverse (when the subsidiary merges into the target and the
target survives).
B. ACQUISITIONS.
An acquisition or takeover is the purchase by one company of controlling interest in the share capital, or all
or substantially all of the assets and/or liabilities, of another company. A takeover may be friendly or hostile,
depending on the offerer company’s approach, and may be effected through agreements between the offerer
and the majority shareholders, purchase of shares from the open market, or by making an offer for acquisition
of the offeree’s shares to the entire body of shareholders.
Friendly takeover: Also commonly referred to as ‘negotiated takeover’, a friendly takeover involves an
acquisition of the target company through negotiations between the existing promoters and prospective
investors. This kind of takeover is resorted to further some common objectives of both the parties.
Hostile Takeover: A hostile takeover can happen by way of any of the following actions: if the board rejects
the offer, but the bidder continues to pursue it or the bidder makes the offer without informing the board
beforehand. The acquisition of one company (called the target company) by another (called the acquirer) that
is accomplished not by coming to an agreement with the target company's management, but by going directly
to the company’s shareholders or fighting to replace management in order to get the acquisition approved. A
hostile takeover can be accomplished through either a tender offer or a proxy fight.
Leveraged Buyouts: These are a form of takeovers where the acquisition is funded by borrowed money.
Often the assets of the target company are used as collateral for the loan. This is a common structure when
acquirers wish to make large acquisitions without having to commit too much capital, and hope to make the
acquired business service the debt so raised.
Bailout Takeovers: Another form of takeover is a ‘bail out takeover’ in which a profit making company
acquires a sick company. This kind of takeover is usually pursuant to a scheme of
reconstruction/rehabilitation with the approval of lender banks/financial institutions. One of the primary
motives for a profit making company to acquire a sick/loss making company would be to set off of the losses
of the sick company against the profits of the acquirer, thereby reducing the tax payable by the acquirer. This
would be true in the case of a merger between such companies as well.
C. STRATEGIC ALLIANCE
A partnership with another business in which you combine efforts in business efforts in a business effort
involving anything from getting a better price for goods by buying bulk together, to seeking business
together, with each of you providing part of the product. The basic idea behind alliances is to minimize risk
while maximising your leverage.
D. JOINT VENTURES.
A joint venture is the coming together of two or more businesses for a specific purpose, which may or may
not be for a limited duration. The purpose of the joint venture may be for the entry of the joint venture parties
into a new business, or the entry into a new market, which requires the specific skills, expertise, or the
investment of each of the joint venture parties. The execution of a joint venture agreement setting out the
rights and obligations of each of the parties is usually a norm for most joint ventures. The joint venture
parties may also incorporate a new company which will engage in the proposed business. In such a case, the
byelaws of the joint venture company would incorporate the agreement between the joint venture parties.
E. DEMERGERS.
A demerger is the opposite of a merger, involving the splitting up of one entity into two or more entities. An
entity which has more than one business, may decide to ‘hive off’ or ‘spin off’ one of its businesses into a
new entity. The shareholders of the original entity would generally receive shares of the new entity. If one of
the businesses of a company is financially sick and the other business is financially sound, the sick business
may be demerged from the company. This facilitates the restructuring or sale of the sick business, without
affecting the assets of the healthy business. Conversely, a demerger may also be undertaken for situating a
lucrative business in a separate entity. A demerger, may be completed through a court process under the
Merger Provisions, but could also be structured in a manner to avoid attracting the Merger Provisions.
The terms "demerger", "spin-off" and "spin-out" are sometimes used to indicate a situation where one
company splits into two, generating a second company which may or may not become separately listed on a
stock exchange.
F. DIVESTITURES
A Divestiture is the sale of part of a company to a third party. Assets, product lines, subsidiaries, or divisions
are sold for cash or securities or some combination thereof. The buyers are typically other corporations or,
increasingly, investor groups together with the current managers of the divested operation.
Reasons : Dismantling Conglomerates
Restructuring activity
Adding Value by selling into a better fit
Large additional investment required
Harvesting Past investments successfully
Discarding Unwanted Business divisions
G. LEVERAGED BUYOUTS (LBO)
A leveraged Buyout or “Bootstrap” transaction occurs when a financial sponsor gains control of a majority
of a target company’s equity through the use of borrowed money or debt. A LBO is essentially a strategy
involving the acquisition of another company using a significant amount of borrowed money (bonds or loans)
to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the
loans in addition to the assets of the company.
H. EMPLOYEE STOCK OPTION PLAN (ESOP)
ESO plans are allows employees can buy company’s stock after certain length of employment or they can
buy share at any time. Some corporations have policies to compensate employees with company’s shares
instead of other monetary benefits. This will increase the accountability and commitment of employee with
his work and organizational growth. At the same time accumulation of shares to employees hands also
A sell-off, also known as a divestiture, is the outright sale of a company subsidiary. Normally, sell-offs are
done because the subsidiary doesn't fit into the parent company's core strategy. The market may be
undervaluing the combined businesses due to a lack of synergy between the parent and subsidiary. As a
result, management and the board decide that the subsidiary is better off under different ownership.
J. EQUITY CARVE-OUTS More and more companies are using equity carve-outs to boost shareholder
value. A parent firm makes a subsidiary public through an initial public offering (IPO) of shares, amounting
to a partial sell-off. A new publicly-listed company is created, but the parent keeps a controlling stake in the
newly traded subsidiary
K. SPINOFFS
A spinoff occurs when a subsidiary becomes an independent entity. The parent firm distributes shares of the
subsidiary to its shareholders through a stock dividend. Since this transaction is a dividend distribution, no
cash is generated. Thus, spinoffs are unlikely to be used when a firm needs to finance growth or deals. Like
the carve-out, the subsidiary becomes a separate legal entity with a distinct management and board.
E Merger & Acquisition
Basic Concepts
Mergers and acquisitions represent the ultimate in change for a business. No other event is more difficult,
challenging, or chaotic as a merger and acquisition. It is imperative that everyone involved in the process has
a clear understanding of how the process works. Hopefully this short course will provide you with a better
appreciation of what is involved. You might be asking yourself, why do I need to learn the merger and
acquisition (M & A) process? Well for starters, mergers and acquisitions are now a normal way of life within
the business world. In today's global, competitive environment, mergers are sometimes the only means for
long-term survival. In other cases, such as Cisco Systems, mergers are a strategic component for generating
long-term growth. Additionally, many entrepreneurs no longer build companies for the long-term; they build
companies for the short-term, hoping to sell the company for huge profits. In her book The Art of Merger and
Acquisition Integration, Alexandra Reed Lajoux puts it best: Virtually every major company in the United
States today has experienced a major acquisition at some point in history.
M & A Defined
When we use the term "merger", we are referring to the merging of two companies where one new company
will continue to exist. The term "acquisition" refers to the acquisition of assets by one company from another
company. In an acquisition, both companies may continue to exist. However, throughout this course we will
loosely refer to mergers and acquisitions ( M & A ) as a business transaction where one company acquires
another company. The acquiring company will remain in business and the acquired company (which we will
sometimes call the Target Company) will be integrated into the acquiring company and thus, the acquired
company ceases to exist after the merger.
Distinction between Mergers and Acquisitions
Although they are often uttered in the same breath and used as though they were synonymous, the terms
merger and acquisition mean slightly different things. When one company takes over another and clearly
established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the
target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be
traded. In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to
go forward as a single new company rather than remain separately owned and operated. This kind of action is
more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company
stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms
merged, and a new company, DaimlerChrysler, was created. In practice, however, actual mergers of equals
don't happen very often. Usually, one company will buy another and, as part of the deal's terms, simply allow
the acquired firm to proclaim that the action is a merger of equals, even if it's technically an acquisition.
Being bought out often carries negative connotations, therefore, by describing the deal as a merger,
Merger Theories
Differential efficiency theory.
Inefficient management theory.
Synergy.
Pure diversification.
Strategic realignment to changing environment.
Hubris hypothesis
Differential efficiency theory.
According to this theory if the management of firm A is more efficient than the firm B and if the firm A
acquires firm B, the efficiency of firm B is likely to be brought up to the level of the firm A.
The theory implies that some firms operate below their potential and as a result have below average
efficiency. Such firms are most vulnerable to acquisition by other more efficient firms in the same
industry. This is because firms with greater efficiency would be able to identify firms with good
potential but operating at lower efficiency.
According to this theory, some firms operate below their potential and consequently have low efficiency. Such firms are likely to be acquired by other, more efficient firms in the same industry. This is because, firms with greater efficiency would be able to identify firms with good potential operating at lower efficiency. They would also have the managerial ability to improve the latter’s performance.
However, a difficulty would arise when the acquiring firm overestimates its impact on improving the performance of the acquired firm. This may result in the acquirer paying too much for the acquired
firm. Alternatively, the acquirer may not be able to improve the acquired firm’s performance up to the level of the acquisition value given to it. The managerial synergy hypothesis is an extension of the differential efficiency theory. It states that a firm, whose management team has greater competency than is required by the current tasks in the firm, may seek to employ the surplus resources by acquiring and improving the efficiency of a firm, which is less efficient due to lack of adequate managerial resources. Thus, the merger will create a synergy, since the surplus managerial resources of the acquirer combine with the non-managerial organizational capital of the firm. When these surplus resources are indivisible and cannot be released, a merger enables them to be optimally utilized. Even if the firm has no opportunity to expand within its industry, it can diversify and enter into new areas. However, since it does not possess the relevant skills related to that business, it will attempt to gain a ‘toehold entry’ by acquiring a firm in that industry, which has organizational capital along with inadequate managerial capabilities.
Inefficient management theory.
This is similar to the concept of managerial efficiency but it is different in that inefficient management
means that the management of one company simply is not performing upto its potential.
Inefficient management theory simply represents that is incompetent in the complete sense.
Synergy.
Synergy refers to the type of reactions that occur when two substances or factors combine to produce
a greater effect together than that which the sum of the two operating independently could account
for.
The ability of a combination of two firms to be more profitable than the two firms individually.
There are two types of synergy:
Financial synergy.
Operating synergy.
Pure diversification.
Diversification provides numerous benefits to managers, employees, owners of the firms and to the
firm itself. Diversification through mergers is commonly preferred to diversification through internal
growth, given that the firm may lack internal resources or capabilities requires.
Strategic realignment to changing environment.
It suggests that the firms use the strategy of M&As as ways to rapidly adjust to changes in their external
environments. When a company has an opportunity of growth available only for a limited period of time
slow internal growth may not be sufficient.
Hubris hypothesis
Hubris hypothesis implies that manager’s look for acquisition of firms for their own potential motives
and that the economic gains are not the only motivation for the acquisitions. This theory is
particularly evident in case of competitive tender offer to acquire a target. The urge to win the game
often results in the winners curse refers to the ironic hypothesis that states that the firm which
overestimates the value of the target mostly wins the contest.
Module - II
Valuing synergy in M&A deals A
Every merger has its own unique reasons why the combining of two companies is a good business decision.
The underlying principle behind mergers and acquisitions ( M & A ) is simple: 2 + 2 = 5. The value of
Company A is $ 2 billion and the value of Company B is $ 2 billion, but when we merge the two companies
together, we have a total value of $ 5 billion. The joining or merging of the two companies creates additional
value which we call "synergy" value.
Synergy value can take three forms:
1. Revenues: By combining the two companies, we will realize higher revenues then if the two companies
operate separately.
2. Expenses: By combining the two companies, we will realize lower expenses then if the two companies
operate separately.
3. Cost of Capital: By combining the two companies, we will experience a lower overall cost of capital.
Why Mergers?- Motives
The dominant rationale used to explain M&A activity is that acquiring firms seek improved financial
performance. The following motives are considered to improve financial performance:
Economy of scale: This refers to the fact that the combined company can often reduce its fixed costs
by removing duplicate departments or operations, lowering the costs of the company relative to the same
revenue stream, thus increasing profit margins.
Economy of scope: This refers to the efficiencies primarily associated with demand-side changes,
such as increasing or decreasing the scope of marketing and distribution, of different types of products.
Increased revenue or market share: This assumes that the buyer will be absorbing a major competitor
and thus increase its market power (by capturing increased market share) to set prices.
Cross-selling: For example, a bank buying a stock broker could then sell its banking products to the
stock broker's customers, while the broker can sign up the bank's customers for brokerage accounts. Or, a
manufacturer can acquire and sell complementary products.
Synergy: For example, managerial economies such as the increased opportunity of managerial
specialization. Another example are purchasing economies due to increased order size and associated
bulk-buying discounts.
Taxation: A profitable company can buy a loss maker to use the target's loss as their advantage by
reducing their tax liability. In the United States and many other countries, rules are in place to limit the
ability of profitable companies to "shop" for loss making companies, limiting the tax motive of an