Mergers and Acquisitions IFAP session (1)

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MA Introduction Level 1 Module 1 Session
1 IFAP Reshma Krishnan
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Why are you here?

• To understand what an Analyst does in the context
  of Corporate finance and Investment Banking
• To acquire skills critical to being a good
  analyst
• To go beyond corporate finance theory

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Logistics

• Programme Manager MA track faculty- Reshma
  Krishnan
• Email re.krishnan_at_gmail.com
• Programme Administrator soft skill faculty
  Pradeep Khanapure
• Pradeep.khanapure_at_imarticus.org
• Faculty- Harish Menon
• Faculty Hemal Lotia
• Walk-in hours Saturday 9-10 (Before Class) on
  notified days

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Financial Analysis Landscape
EQUITY CREDIT RESEARCH
INVESTMENT BANKING
PROJECT FINANCE
CONSULTING

• Capital Raising
• Debt
• Equity
• Advisory Services
• MA
• Restructuring

• Corporate Finance Advisory
• Forensic and Dispute Services
• M A Transaction Services
• Reorganisation Services

• Project Structuring
• Portfolio Monitoring and Collections
• Risk Analysis
• Debt, Sub-debt, Quasi-Equity Funding, Equity
  Investments

• Analysis of stock markets worldwide
• Economic, Strategy and Commodities Research
  Analysis
• Corporate Debt

FINANCIAL ANALYSIS
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Two guiding Principles
How do I become bigger? Increase my sales
faster and in a sustained manner?
Top Line
How do I make more money? Increase my
profitability in a faster and
Bottom Line
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Vehicles of Growth
Make or Buy?
Hedge Funds Mutual Funds Insurance Companies
HNI Wealth Management

• Organic- Greenfield
• Time
• Resources

Brokerage Firms IPO Equity Research Analysts
Analyst
Buy-side
Sell-side
Equity Capital Markets

• Inorganic
• MA
• Options
• Market
• Price

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Why should you buy? - Strategic Rationale For MA
REVENUE
Start-up
Growth
Maturity
Transformation
TIME
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What is MA and how does it create value?

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• The key principle behind buying a company is to
  create shareholder value over and above that of
  the sum of the two companies. Two companies
  together are more valuable than two separate
  companies - at least, that's the reasoning behind
  MA.

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MA is not one word

• Mergers- Merger of equals. 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.
• Rare
• Exchange of Stock
• Daimler- Benz Chrysler merged to become Daimler
  Chrysler
• Acquisition-When one company takes over another
  and clearly established itself as the new owner,
  the purchase is called an acquisition
• More often the case
• Will buy the entire stock of the company
• Tata buying Jaguar

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The concept of Synergy- the Holy Grail of MA

• The magic behind the MA the holy grail
• Staff Reductions
• Competition elimination
• Economies of Scale
• Acquiring new technology
• Improved Market Reach and Industry Visibility

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Types of MA
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Understanding the value chain of an industry

• Changing Industry structure The disappearance of
  middle man is advantageous to players such as
  Glitter who do not depend on them for raw
  materials and now have the opportunity to cater
  to major customers like jewellery manufacturers
  and retailers on their own leading to a
  significant expansion in margins.
• Inorganic Growth Opportunities Glitter can focus
  its inorganic growth efforts across the value
  chain enabling it to spur its growth
  exponentially over the coming years as the
  fragmented industry starts to consolidate.

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Valuation in MA- How much will you pay?
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Control Premium

• For the most part, acquiring companies nearly
  always pay a substantial premium on the stock
  market value of the companies they buy. The
  justification for doing so nearly always boils
  down to the notion of synergy a merger benefits
  shareholders when a company's post-merger share
  price increases by the value of potential
  synergy.
• Pre Merger value of both firms Synergy Pre
  Merger Stock Price Post Merger Number of Shares

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Indian MA Market An Overview
MA in India has grown at a significant rate
between 2003 and 2007 at a CAGR of almost 58
with focus being on IT ITES, Telecom, Energy
Life sciences sectors. A majority of the MA
transactions had been cross-border in nature.

• Indian MA Market
• Domestic
• Cross border
• Inbound- No mega deals
• Outbound- Decline in the last few years
  because of the Global Crisis.

• Global MA
• Down 2 to 2.78 Trillion
• Oil Gas Led the Global Sector
• 42,455 deals
• The 54.5bn pending bid for
• TNK-BP by Rosneftegaz, announced on 22nd October,
  was the largest deal of the year and accounted
  for 14 of total Oil Gas volume

Source Grant Thornton
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MA Pitfalls- why over half of them fail to
create any value
Evaluation
Diligence
Implementation

• Overestimate Savings and imagine the synergies
  dont exist.
• Underestimate integration and deal costs.

• Cultural Clash Companies are like people and
  have their own personalities. Merging two
  extremely different cultures often results in a
  failed merger.

• Inadequate Due Diligence This often happens in
  the auction process when speed is of the essence
  and buyers are expected to finish due diligence
  quickly to ensure Closure of transaction.

February 20, 2007, Bear Sterns ordered by a U. S.
Bankruptcy Judge in New York to repay 159
million to the Trustee of Manhattan Investment
Fund Ltd. for providing services to the fund from
1996 to 2000 provides a stark example of the huge
risk-to-reward gulf if your companys due
diligence procedures are not what they should be.
The 2002 merger of HP and Compaq is a good
example of culture clash. Significant differences
were Compaq tended was market-oriented and
aggressive, while the traditional HP emphasized
teamwork, consensus and long-term view.
Consulting firms helped HP conduct 144 focus
groups and 150 interviews in 22 countries. These
firms discovered that the situation was
ready-made for massive culture clash.
Merger of AOL-Time Warners synergies ascribed to
the deal were over sold. The shareholders of AOL
owned 55 of the new company while Time Warner
shareholders owned only 45, wall street worry
was that the smaller AOL had in fact bought out
the far larger Time Warner.
Deal Heat/ winners Curse Bidders get caught up
in a deal and lose sight of value and strategic
fit and focus on winning thereby losing synergies.
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Tata Corus- An analysis of why this time is
different
CORUS FAILURE

• Corus, the merger between British Steel and
  Hoogovens in 1999, underestimated the integration
  valuing the companies market cap at US 6
  billion, but in 2005 the company was worth US
  250 million.
• Corus was an attempt to revive the ailing British
  Steel which had incurred a net loss of 81
  million in the March 1999.
• Coruss Failure
• Chief among them being the cultural mismatch
  between the merged entities and the lack of HR
  involvement when integrating the two entities.
• Large scale labour unrest due to the downsizing
  and rationalization of various operations
  seriously impacted the normal functioning of the
  new organization.
• The high valuation of the British pound and
  stagnation in demand for steel was gradually
  undermining the competitiveness of British Steel
  in the European market.

Wishful Thinking!
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Tata Corus- An analysis of why this time is
different
TATA CORUS DEAL

• Tata Steel acquired Britains Corus for 5.75
  billion (11.3 billion now 12.1) in 2007.
• Tata-Corus combine will become the fifth largest
  steelmaker in the world.
• The New TATA-Corus
• Access to low-cost slabs
• The ability to export surplus slabs either from
  Tata Steel's facilities or through acquisitions
  in low-cost regions over the next few years will
  be the key driver of this deal.
• Restructuring of Corus' existing units
• It is likely that over the next few years, Tata
  Steel will put through an extensive restructuring
  of its underperforming units at Port Talbot and
  Scunthorpe in the UK, though it has ruled out any
  job cuts. It may also prune down high-cost slab
  facility at Teesside.
• Better Implementation and management of Cultural
  issues
• The ruling out of job cuts creates a better
  environment post integration unlike the one seen
  in the earlier transaction.
• Quantified Potential synergies
• For the first time since this deal surfaced, Tata
  Steel has quantified that it will benefit to the
  tune of 300-350 million every year. However, the
  benefits from the deal may be lower than this
  amount spelt out in the first two years and
  attain this level from the third year onwards.

Wishful Thinking!
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Winners Curse!

• A tendency for the winning bid in an auction to
  exceed the intrinsic value of the item purchased.
  
• Tata Corus had quantified synergies but many
  reckon that they might have bid almost
• The acquisition by Tata amounted to a total of
  608 pence per ordinary share or 6.2 billion (US
  12 billion) which was paid in cash. First of
  all, the general assumption is that the
  acquisition was not cheap for Tata. The price
  that they paid represents a very high 49 premium
  over the closing mid market share price of Corus
  on 4 October, 2006 and a premium of over 68 over
  the average closing market share price over the
  twelve month period. Moreover, since the deal was
  paid for in cash automatically makes it more
  expensive, implying a cash outflow from Tata
  Steel in the amount of 1.84 billion.

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