Financial Managment about (Mergers & Acquisitions) - Essay Example

Financial Management "Sometimes two companies may be more valuable than a part" This ment reflects the reasoning behind Merger and Acquisitions.It signifies the newer trend of more and more inclination towards consolidation by way of Mergers and acquisitions (M&A). Today corporate restructuring are becoming a big part of the corporate finance world. Periodic environmental appraisal and organizational appraisal lead to generation of strategic alternatives. The strategic alternatives are then evaluated in the context of organizational strengths, weaknesses, opportunities and threats. Expansion strategy is followed when an organization wishes to broaden the scope of its customer groups, functions, alternative technologies etc. Merger and Acquisition (or takeover) strategies basically involve the external approach to expansion. In this process basically two or occasionally more than two entities are involved. Mergers take place when the objectives of the buyer company and the seller company are matched to a large extent, while takeovers or acquisitions are usually based on the strong motivation of the buyer company. Takeovers are frequently classified as hostile takeovers (which are against the wishes of the acquired company) and friendly takeovers (by mutual consent in which case they could also be described as a merger). The purported key principle behind buying a company is to create shareholder value over and above that of the sum of the two companies. In a nutshell the key factors leading to M& A are; Consolidation of business i.e. to improve stability of earnings and sales Taking the competition head-on Business rivalry As part of a modernization plan To increase the value of the organizations' stock To increase growth rate and make a good investment Building a strong brand To balance compete or diversify in a new segment/ market To avail tax concessions and benefits. To take advantage of synergy To deal with top management succession problems A merger is a combination of two or more organizations in which one acquires the assets and liabilities of the other in exchange for shares or cash, or both the organizations are dissolved, and assets and liabilities are combined and new stock is issued. For the organization which is acquired it is merger. For the organization which acquires another, it is acquisition. If both organizations dissolve their identity to create a new organization, it is called consolidation or amalgamation. Mergers are also classified as; Horizontal Mergers: When there is a combination of two or more organizations in the same business, or of companies engaged in similar aspects of production or marketing processes. For example a steel making company combining with another steel making company. Vertical Mergers: When there is a combination of two or more organizations, not necessarily in the same business, which creates complimentary situation either in terms of supply of materials (inputs) or marketing of goods and services (outputs). For example a footwear manufacturing company combining with a leather tannery or with a chain of shoe retail stores. Concentric Mergers: When there is a combination of two or more organizations related to each other either in terms of customer functions, customer groups or alternative technologies used. For example a computer motherboard making company combining with a peripheral devices making company. Conglomerate Mergers: When there is a combination of two or more organizations unrelated to each other, either in terms of customer functions, customer groups, or alternative technologies used. For example an IT company joining hands with a footwear manufacturing company. For mergers to take place two organizations have to act. Both these organization have certain set of reasons for taking this step and accordingly they go into preparations and negotiations. Four key aspects to getting acquisitions right; Pre-deal phase: It includes negotiations and rigorous due diligence like business due diligence, people due diligence, accounting due diligence and legal due diligence. Pricing: It includes getting the pricing right. This requires lot of maneuverability on the part of the parties concerned. Experts say that valuation is more of an art than a science. Positioning: This ensures that the strategic direction of the deal moves in the right direction. People management: in the entire value chain, form pre-deal activities to the integration phase people management has a unique place. For a successful acquisition the homework has to be quite comprehensive and there are certain prerequisites that a potential acquirer needs to work upon like; He needs to have a high degree of clarity on the kind of acquisition that he wants to have. Knowledge about the sector he is going to enter. Key understanding of the distribution channels and the industry segmentation Clear understanding of the market structure The acquirer must take a proactive role rather than being reactive to market situations and acquisition trends. Studying such factors would ensure how a potential acquisition fits into the existing business and the overall strategy. Initially, in most of the cases, it appears to be a conflicting situation. What makes the negotiations much more important is the requirement to strike a 'win-win' solution. Management gurus say that during negotiations one must have; A clear understanding of the objectives and strategic imperatives A well researched factual report supporting the case. A proper back-up plan and alternatives in an unbiased manner. During negotiations one must always be ready for surprises. A decent body language which communicates the interests of the company and seriousness of the matter. A company yet flexible attitude with a focus of the areas of agreement and one must try to create a sense of achievement around them. A list of sweet spots and pain points of the other company since we are up against some of the leading competitors in the business. Valuation and Pricing: A valuation task is a relatively complex task in any M&A exercise. This is a process of determining the current worth of an asset or company. Often the calculations give an arithmetic price which may not always give the full story. There's lot more to 'Value' than 'Price' and one need to understand the journey from price to value. Value is regarded something as 'worthy' or 'desirable'. Valuation in general depends upon; Industry sector dynamics Market sentiments Competitive auction Intangibles like quality of management, goodwill etc. Healthy targets versus financially troubled targets. The stage of evolution of the target company Potential liabilities such as environmental claims, tax demands and off balance sheet liabilities. In arriving at the right value, the key is to understand the relevant value drivers like base price, synergy value, strategic value, competitive value, control value and targeted value. The analysis of financial aspects of M&A covers three aspects viz. i. Determining the company's value ii. Financing techniques for M&A, and iii. Merger as a capital budgeting technique Determining the worth of a company is the first step. In estimating the value of a company several factors are considered in conjunction with one another. The book value though not an effective measure by itself, is useful in specific situations. The appraisal value may or may not be a good indicator to be paid for a company. Its merit depends upon the approach adopted, and the nature of the business. The market value is the key element in evaluating a company's worth, particularly in case of large listed corporate. The Earning Per Share (EPS) is an important criterion for merger decisions. However, a company's worth should not be determined on the basis of a single approach and a single figure, but, within a range, on the basis of consideration of all alternative approaches. The EPS basis of determining the value of the company is based on the effect of merger on the future EPS, i.e. the EPS of the merged company (EPSm), which is determined using; EPSm = (EATa + EAT t) / (Na+Nt) Where, EATa = Earnings after taxes of acquiring company EATt = Earnings after taxes of target company Na = Number of equity shares outstanding of acquiring company Nt = Number of equity shares issued to the shareholders of the target company Similarly the market value of the merged company can be calculated Vm = EPS * P/Ea Where, Vm = Market value of the merged company P/Ea = Price/ Earning ratio of the acquiring company To calculate total gain from merger we use; Total gain = Vm - (Va+Vt) Where Va = EPSa*P/Ea Vt = EPSt*P/Et The gains for respective companies can be calculated like; Ga = [Post merger value of company A - Pre merger value of company A] Gt = [Post merger value of company T - Pre merger value of company T] Different approaches for estimating the intrinsic value of a common stock are; i. Dividend growth model: Value of a stock is the present value of the future dividends expected to be generated by the stock. i.e. Po = [ D1/(1+Rs)1 + D2 /(1+Rs)2 + D3 (1+Rs)3 + + D/(1+Rs) ] where Po = Present value Rs = Rate of return D = Dividend for respective years A stock whose dividends are expected to grow forever at a constant rate, g. D1 = D0 (1+g)1 D2 = D0 (1+g)2 Dt = D0 (1+g)t ii. Corporate value model: This is also called the free cash flow method. This suggests that the value of the entire company equals the present value of the company's free cash flows. This way the market value of the company is found by finding the Present Value of the company's Future Cash Flows. Where, Future Cash Flow = Net Operating Profit After Tax - Net capital investment This method is often preferred to the dividend growth model, especially when considering number of companys that don't pay dividends or when dividends are hard to forecast. iii. Using the multiples of comparable companies: Analysts often use the following multiples to value stocks. P / E P / CF P / Sales In this method based on comparable firms, P/E is estimated appropriately which is then multiplied by expected earnings to back out an estimate of the stock price. Some recent M&As 1. Arcelor Merges into rival Mittal Steel: On June 24, 2006 a new steel giant was created after Arcelor of UK formally agreed to a 26.5 billion takeover by its rival Mittal Steel. The deal, valued at $33.1 billion, makes the largest steel maker company in the world. This M&A was in news for many interesting reasons. At times it appeared that the deal is finished because Arcelor's management dismissed Mittal steels as a 'company of Indians', but the shareholders took a centre-stage, who saw 'value' in this deal. They threatened to revolt. Even political big-wigs were there to criticize the 'hostile' bid of Mr. Lakshmi Mittal. Mittal stell agreed to pay 40.37 a share for Arcelor, nearly double what the company was trading at when Mittal first made an offer in January 2006. The new company will now be named 'Arcelor-Mittal' and will be headquartered in Luxembourg. For the time being Joseph Kinsch, chairman of Arcelor, will be chairman of the new company as well, and will be succeeded by Mittal when Kinsch retires next year. After the deal Kinsch said that the deal would create "global leadership in steel" not just by ton but by value. Earlier the initial offer of 18.6 billion offer for Arcelor from Mittal steel was swiftly rejected by Arcelor management and simultaneously kept negotiating with Severstal of Russia to keep continuous pressure on Mittal, which finally paid rich dividends. In fact, Arcelor's shareholders, including institutional investors and a growing number of hedge funds, played a crucial role in this entire episode. They were angry enough about the way the last- minute deal with Severstal was being pushed. Such shareholder revolts have also been successful in the past. Last year, for example, the chief executive of Deutsche Brse, Werner Siefert, was forced out after shareholders opposed his plans to buy the London Stock Exchange. The sale price also brought windfall for the shareholders of Arcelor with a hefty premium to Arcelor's last trading price of 35.02 a share. The merger has been termed as a milestone in the consolidation of the global steel industry, creating a behemoth with three times the capacity of its nearest rival, Nippon Steel, and 10 percent of global market share. With 320,000 employees and an estimated $70 billion in revenue, the combined company will be the first steel maker with more than 100 million tons of annual capacity - enough for twice as many automobiles as the world makes every year. The new company has also announced third quarter (2006) results as well with Pro forma EBITDA of US$4.4 billion, up 24% over Q2 2006. the company also announced that it has recorded the following preliminary adjustments: Inventory Inventory has increased by $715 million as of the acquisition date (August 1, 2006) of which $525 million has been expensed ($310 million net of tax and minority interest) as of September 30, 2006. The pro forma income statement excludes the effects of this adjustment. While the Company has analyzed most of its inventory, additional analysis may result in further adjustments in future periods. Tangible fixed assets: The new Company has increased the tangible fixed assets acquired by $11.5 billion. The Company has also assessed the remaining useful lives of these assets and concluded that the assets acquired have a longer average remaining useful life then previously estimated by Arcelor. The Company therefore estimates, on a preliminary basis, the annual additional depreciation charge at $60 million. Employee benefits: Preliminary actuarial calculations (present value calculations) of the employee benefit obligations of Arcelor as of the acquisition date have been performed. These calculations indicate that the employee benefit obligations as previously recognized by Arcelor, will be increased by $125 million. Goodwill: As a result of the above preliminary purchase price allocation adjustments the Company currently estimates the goodwill for the acquisition of Arcelor at $6.7 billion. 2. Corus steel (Corus Group Plc) of UK merges with Tata Steel of India: This was a real hush-hush affair merger. The world got no hint of the negotiations and the deal till the very last moment. This goes on to show that both the companies displayed a thorough professional and mature conduct throughout the entire negotiation process. Prior to signing the deal paper Wall Street Journal wrote, "The $8.05 billion acquisition of Europe's second-largest steelmaker, if it goes through, will give Tata Steel instant access to new international customers for its inexpensive steel. More importantly, the acquisition would give it the capacity and technology it needs to keep up with the rapidly expanding demand for steel from the Indian economy." As soon as the news of a deal of this magnitude hit Indian news arena there was panic selling on the counter of Tata steel considering the 'big' price Tata agreed to pay for Corus. On the other hand the share price of Corus started rising in London, owing to a good deal. But now situation has stabilized at both ends. Corus is Europe's second largest steel producer with revenues in 2005 of GBP 9.2 billion, and crude steel production of 18.2 million tons primarily in U.K. and Netherlands. The deal was stuck for an acquisition of the entire issued share capital of Corus Group plc, at a price of 455 pence in cash for each share valuing Corus at GBP 4.3 billion. Tata group of India is a 139 year old brand with group revenue of approx US $22 Billion. It is the largest employer in the public sector in India with a total work force of more than 235,000, ranked as world number one steel maker by WSD. Its current consolidated EBITDA margin is 30-35%. Incidentally Corus also met with numerous companies over the past year to consider ways to increase its presence outside Europe through a merger or partnership. After meeting with companies in Russia and Latin America, the Anglo-Dutch steel producer announced the Tata deal on October, 20 2006. The talks were underway for the last one year. Just prior to the deal some of the shareholders of Corus, including its largest investor, Standard Life, also accused the company's management of selling out too cheaply to Tata. For the year ended 31 December 2005, Corus reported revenues of approximately 9.2 billion, EBITDA of 947 million and profit after tax of 432 million (all as restated for continuing operations in the first quarter 2006 results announcement, thus excluding the downstream aluminum rolled products and extrusion businesses which were sold in August 2006). Also for the half year ended 1 July 2006, on a continuing operations basis, Corus reported revenues of approximately 4.7 billion, EBITDA of 433 million and profit after tax of 106 million. The Acquisition will be funded by a cash contribution (funded by a mixture of its own cash resources and drawings under bank facilities) by Tata Steel to Tata Steel UK (through the intermediary companies described in paragraph 7 above) to the extent of approximately 1,060 million. As a result of the merger the workers at the giant Corus steel plant at Port Talbot were amongst the first one's voicing their concern that they will be in the firing line when the dreaded word "rationalisation" is eventually used by their new owners. But the management of Tata has so far given no such hint. Read More