Question

1. Takeover is a general and imprecise term referring to the transfer of control of a firm from one group of shareholders to another. This can occur through any one of three means: acquisitions, proxy contests, and going-private transactions. Discuss THREE (3) basic legal procedures that one firm can use to acquire another firm.

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2. One important reason for an acquisition is that the combined firm may generate greater revenues than two separate firms. Increase in revenue may come from marketing gains, strategic benefits, and increase in market power. Briefly describe this revenue enhancement to the company.                                                                                   

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Answer 1

Answer a.)

THE BASIC FORMS OF ACQUISITIONS

There are three basic legal procedures that one firm can use to acquire another firm:

(1) Merger or Consolidations

(2) Acquisition of stock

(3) Acquisition of assets

(1) Merger or Consolidations

A merger is generally understood to be a fusion of two companies. The term “merger” means and signifies the dissolution of one or more companies or firms or proprietorships to form or get absorbed into another company. By concept, merger increases the size of the undertakings. Following are major types of mergers:

1. Horizontal Merger: The two companies which have merged are in the same industry, normally the market share of the new consolidated company would be larger and it is possible that it may move closer to being a monopoly or a near monopoly to avoid competition.
2. Vertical Merger: This merger happens when two companies that have ‘buyer-seller’ relationship (or potential buyer-seller relationship) come together.
3. Conglomerate Mergers: Such mergers involve firms engaged in unrelated type of business operations. In other words, the business activities of acquirer and the target are neither related to each other horizontally (i.e., producing the same or competiting products) nor vertically (having relationship of buyer and supplier).In a pure conglomerate merger, there are no important common factors between the companies in production, marketing, research and development and technology. There may however be some degree of overlapping in one or more of these common factors. Such mergers are in fact, unification of different kinds of businesses under one flagship company. The purpose of merger remains utilization of financial resources, enlarged debt capacity and also synergy of managerial functions.
4. Congeneric Merger: In these mergers, the acquirer and the target companies are related through basic technologies, production processes or markets. The acquired company represents an extension of product-line, market participants or technologies of the acquirer. These mergers represent an outward movement by the acquirer from its current business scenario to other related business activities within the overarching industry structure.
5. Reverse Merger: Such mergers involve acquisition of a public (Shell Company) by a private company, as it helps private company to by-pass lengthy and complex process required to be followed in case it is interested in going public.
6. Acquisition: This refers to the purchase of controlling interest by one company in the share capital of an existing company. This may be by:
7. 1. an agreement with majority holder of Interest.
   2. Purchase of new shares by private agreement.
   3. Purchase of shares in open market (open offer)
   4. Acquisition of share capital of a company by means of cash, issuance of shares.
   5. Making a buyout offer to general body of shareholders.

8. When a company is acquired by another company, the acquiring company has two choices, one, to merge both the companies into one and function as a single entity and, two, to operate the taken-over company as an independent entity with changed management and policies. ‘Merger’ is the fusion of two independent firms on co-equal terms. ‘Acquisition’ is buying out a company by another company and the acquired company usually loses its identity. Usually, this process is friendly.

(2) Acquisition of stock

Another way to acquire another firm is to purchase the firm’s voting stock in exchange for cash, shares of stock, or other securities. This may start as a private offer from management of one firm to another. At some point the offer is taken directly to the selling firm’s stockholders. This can be accomplished by use of a tender offer. A tender offer is a public offer to buy shares of a target firm. It is made by one firm directly to the shareholders of another firm. The offer is communicated to the target firm’s shareholders by public announcements such as newspaper advertisements. Sometimes a general mailing is used in a tender offer. However, a general mailing is very difficult because it requires the names and addresses of the shareholders of record, which are mot usually available.

The following are factors involved in choosing between an acquisition of stock and a merger:

1. In an acquisition of stock, no shareholder meeting must be held and no vote is required. If the shareholders of the target firm do not like the offer, they are not required to accept it and they will not tender their shares.

2. In an acquisition of stock, the bidding firm can deal directly with the shareholders of a target firm by using a tender offer. The target firm’s management and board of directors can be bypassed.

3. Acquisition of stock is often unfriendly. It is used in an effort to circumvent the target firm’s management, which is usually actively resisting acquisitions. Resistance by the target firm’s management often makes the cost of acquisition by stock higher than cost of merger.

4. Frequently a minority of shareholders will hold out in a tender offer, and thus the target firm cannot be completely absorbed.

5. Complete absorption of one firm by another requires a merger. Many acquisitions of stock end with a formal merger later.

(3) Acquisition of assets

One firm can acquire another firm by buying all of its assets. A formal vote of the shareholders of the selling firm is required. This approach to acquisition will avoid the potential problem of having minority shareholders, which can occur in an acquisition of stock. Acquisition of assets involves transferring title to assets. The legal process of transferring assets can be costly.

Answer a.)  

The first step in merger analysis is to identify the economic gains from the merger. There are gains, if the combined entity is more than the sum of its parts.

That is, Combined value > (Value of acquirer + Stand alone value of target)

The difference between the combined value and the sum of the values of individual companies is usually attributed to synergy.

Value of acquirer + Stand alone value of target + Value of synergy = Combined value

There is also a cost attached to an acquisition. The cost of acquisition is the price premium paid over the market value plus other costs of integration. Therefore, the net gain is the value of synergy minus premium paid.

VA = `100

VB = ` 50

VAB = ` 175

Where, VA = Value of Acquirer

VB = Standalone value of target And, VAB = Combined Value

So, Synergy = VAB – (VA + VB) = 175 - (100 + 50) = 25

If premium is ` 10, then, Net gain = Synergy – Premium = 25 – 10 = 15

Acquisition need not be made with synergy in mind. It is possible to make money from non- synergistic acquisitions as well. As can be seen from Exhibit, operating improvements are a big source of value creation. Better post-merger integration could lead to abnormal returns even when the acquired company is in unrelated business. Obviously, managerial talent is the single most important instrument in creating value by cutting down costs, improving revenues and operating profit margin, cash flow position, etc. Many a time, executive compensation is tied to the performance in the post-merger period. Providing equity stake in the company induces executives to think and behave like shareholders.

Rationale of M&A

• Diversification: In case of merger between two unrelated companies would lead to reduction in business risk, which in turn will increase the market value consequent upon the reduction in discount rate/ required rate of return. Normally, greater the combination of statistically independent or negatively correlated income streams of merged companies, there will be higher reduction in the business risk in comparison to companies having income streams which are positively correlated to each other.
• Taxation: The provisions of set off and carry forward of losses as per Income Tax Act may be another strong season for the merger and acquisition. Thus, there will be Tax saving or reduction in tax liability of the merged firm. Similarly, in the case of acquisition the losses of the target company will be allowed to be set off against the profits of the acquiring company.
• Growth: Merger and acquisition mode enables the firm to grow at a rate faster than the other mode viz., organic growth. The reason being the shortening of ‘Time to Market’. The acquiring company avoids delays associated with purchasing of building, site, setting up of the plant and hiring personnel etc.
• Consolidation of Production Capacities and increasing market power: Due to reduced competition, marketing power increases. Further, production capacity is increased by the combination of two or more plants.The following table shows the key rationale for some of the well known transactions which took place in India in the recent past.

Instantaneous growth, Snuffing out competition, Increased market share	Airtel – Loop Mobile (2014) (Airtel bags top spot in India Telecom Circle)
Acquisition of a competence or a capability	Google – Motorola (2011) (Google got access to Motorola’s 17,000 issued patents and 7500 applications)
Entry into new markets/product segments	Airtel – Zain Telecom (2010) (Airtel enters 15 nations of African Continent in one shot)
Access to funds	Ranbaxy – Sun Pharma (2014) (Daiichi Sankyo sold Ranbaxy to generate funds)