06 October, 2007

Merger Strategy

Various aspects of the M & A deal such as valuation, legal compliance, accounting and negotiation are highly specialised areas. The advisors are often investment and merchant bankers who are well versed with the M&A market players and have experience and knowledge. Advisors take fees for performing various tasks:

Target identification
Determination of appropriate price
Structuring the finance
Assisting in negotiation
Advising on post-merger integration


The fees charged by the intermediary are often negotiable.
The Lehman formula (also known as 5-4-3-2-1) formula is most popular.

If the target is being sought, the seeker should carefully state the objectives.
For example, the objective(s) may be one or more of:- I
ncreasing market share in domestic market,-
- Eliminating a competitor,
- Enhancing production capacity,
- Entering fast growing markets abroad,
- Leveraging distribution channels,
- Better control of critical input material and components etc.
Merger Procedure
I. Accounting

When mergers and acquisitions take place, the combined entity's financial statements have to reflect the effect of combination. According to the Accounting Standard 14 (AS 14) issued by the Institute of Chartered Accountants of India, an amalgamation can be in the nature of pooling of interests, referred to as "amalgamation in the nature of merger', or acquisition. The conditions to be fulfilled for an amalgamation to be treated as an "amalgamation in the merger " are as follows:

1. All assetss and liabilities of the "Transferor Company" before amalgamation should become assets and liabilities of the "Transferee Company".
2. Shareholders holding not less than 90% of shares (in value terms) of the "Transferor Company" should become the shareholders of the "Transferee Company".
3. The consideration payable to the shareholders of the "Transferor Company" should be in the form of shares of the "Transferee Company" only; cash can however, be paid in respect of fractional shares.
4. Business of the "Transferor Company" is intended to be carried on by the "Transferee Company."
5. The "Transferee Company" incorporates, in its balance sheet, the book values of assets and liabilities of the "Transferor Company" without any adjustment except to the extent needed to ensure uniformity of accounting policies. An amalgamation which does not satisfy all the conditions stated above will be regarded as an "Acquisition".The accounting treatment of an amalgamation in the books of the "Transferee Company" is dependent on the nature of amalgamation. For a merger, the 'pooling of interest' method is to be used and for an Acquisition the 'purchase' method is to be used. Under 'the pooling of interest' method, the balance sheet of the combined entity is arrived at by a line by line addition of the corresponding items in the balance sheets of the combining entities. Hence, there is no asset write-up or write-down or even goodwill. Under the 'purchase' method, however, the "acquiring company" treats the "acquired company" as an acquisition investment and, hence, reports its tangible assets at fair market value. So, there is often an asset write-up. Further, if the consideration exceeds the fair market value of tangible assets, the difference is reflected as goodwill, which has to be amortized over a period of five years. Since there is often an asset write-up as well as some goodwill, the reported profit under the purchase method is lower because of higher depreciation as well as amortization of goodwill.
II. Legal/ Statutary approvals

The process of mergers or amalgamations is governed by sections 391 to 394 of the Companies Act, 1956 and requires the following approvals
Shareholder approvalThe shareholders of the amalgamating and the amalgamated companies are directed to hold meetings by the respective High Courts to consider the scheme of amalgamation. The scheme is required to be approved by 75% of the shareholders, present and voting, and in terms of the voting power of the shares held (in value terms).Further, Section 395 of the Companies act stipulates that the shareholding of dissenting shareholders can be purchased, provided 90% of the shareholders, in value terms, agree to the scheme of amalgamation. In terms of section 81(IA) of the Companies Act, the shareholders of the "amalgamated company" also are required to pass a special resolution for issue of shares to the shareholders of the "amalgamating company".
Creditors/Financial Institutions/Banks approvalApprovals from these are required for the scheme of amalgamation in terms of the agreement signed with them.
High Court approvalsApprovals of the High courts of the States in which registered offices of the amalgamating and the amalgamated companies are situated are required.
Reserve Bank of India approvalIn terms of section 19 of FERA, 1973 Reserve Bank of India permission is required when the amalgamated company issues shares to the nonresident shareholders of the amalgamating company or any cash option is exercised.
SEBI's Takeover Code for substantial acquisitions of shares in Listed companies
In India take-overs are controlled. On 4th November 1994, SEBI announced a take-over code for the regulation of substantial acquisition of shares, aimed at ensuring better transparency and minimizing the occurrence of clandestine deals. In accordance with the regulations prescribed in the code, on any acquisition in a company which makes acquirers's aggregate shareholding exceed 15%, the acquirer is required to make a public offer. The take-over code covers three types of takeovers-negotiated takeovers, open market takeovers and bail-out takeovers.
III. Valuation

There are several approaches to valuation. The important ones are the discounted cash flow approach, the comparable company approach, and the adjusted book value approach. Traditionally, the comparable company approach and the adjusted book value approach were used more commonly. In the last few years, however, the discounted cash flow approach has received greater attention, emphasis, and acceptance. This is mainly because of its conceptual superiority and its strong endorsement by leading consultancy organizations.
The discounted cash flow approach to corporate valuation involves four broad steps:

· Forecast the free cash flow
· Compute the cost of the capital
· Estimate the continuing value
· Calculate and interpret results

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