MODULE V

MERGERS AND ACQUISITION

2 MARKS QUESTIONS

1. What is meant by cross border merger?

In cross boarder merger, a company in one country merges with a company in a foreign
country. It is a merger between firms in different nations. A cross border merger can
be either inbound or outbound. In an inbound merger, a foreign company merges with
or acquires a domestic company.

5 MARKS QUESTIONS
2. Explain internal expansion and types of internal expansion.
Internal Expansion
In the case of internal expansion, a firm grows gradually over time in the normal course
of the business, through acquisition of new assets, replacement of the technologically
obsolete equipments and the establishment of new lines of products.
Types of Internal Expansion
1. Expansion
In this strategy, a firm expands its current business operations through product
development, market development, expanding the lines of product etc…
Expansion leads to better utilisation of the resources and helps to face the
competition efficiently. Business expansion provides economics of large-scale
operations. In expansion strategy, a company has to provide the sufficient
resources which will support the targeted growth rate.
2. Concentration
In concentration strategy, a company chooses to put in most of its resources on
the development of a specific product or a small group of products that are aimed
at a specific market. The purpose of a concentration strategy is to provide a
singular focus to the product line, and the market in which the company chooses
to complete.
3. Diversification
The purpose of diversification is to allow the company to enter new lines of
business that are different from current operations. Diversification strategies
facilitate the expansion of the scope of an organisation across different products
and market sectors.
4. Modernisation – Modernisation strategy involves adoption of new technology or
upgradation of existing technology. Modernisation intends to renew the plant and
machinery and production processes. The modernisation results into increased
production and improvement in the quality of products so that they offer better
value to the customers.

3. Explain merger and reasons for merger.

Merger refers to legal consideration of two or more companies into one
company. It is accomplished by one company purchasing the assets of another
company with cash or its securities or by purchasing the shares of another company
by issuing its stock to the shareholders of that company in exchange for their shares.
Elimination of unhealthy competition, increasing efficiency and diversification of
products and services are the major reasons of a merger strategy.
Reasons for Merger
There are a number of reasons that companies pursue mergers. Some of the
important reasons of mergers are described below;
1. Synergy
The term synergy refers to a combined operation of units to produce results
greater than the individual performance. It is the creation of a whole that is greater
than the simple sum of its parts. Companies can combine their activities through
merger. This will help them to increase profits and reduce costs. Generally, firms
attempt to merge with others having complementary strengths and weaknesses.
2. Increasing Capabilities
Mergers help companies to strengthen their capabilities through expanded
research and more robust manufacturing operations. Merger increases the
revenue and market share. The reason for this phenomenon is that when two firms
merge, it reduces competition and strengthens the market position.
3. Tax Benefits
A merged company gets tax benefits when a profit-making company takes over a
loss-making company and when a company enjoys a subsidised rate of taxation.
Section 21 (B) of the Income Tax Act 1961 offers many reliefs and benefits in the
case of mergers.
4. Diversification
Diversification means growing outside a company’s current industry category. A
company can reduce the impact of a particular industry’s performance on its
profitability by adopting a strategy of diversification through acquisition of another
company in an unrelated industry.
5. Facing Competition
Merger helps to face competition at national as well as international markets.
Merging builds up the strength of companies to beat competition. Through merging
companies can provide goods and services at competitive prices.
6. Elimination of Competition
Merger helps to eliminate future competition and gain a larger market share by
amalgamation of competing firms. It allows the new firm to raise prices and
increase the control over the market and the industry.
7. Economic of Scale
Merger helps firms to reduce cost through increased level of production, buy goods
and services more cheaply through greater bargaining strength. It also facilitates
better resource savings through increased specialisation.
8. Acquisition of New Technology
In order to become competitive, companies need to adapt technological
developments and their business applications. Purchase of smaller companies with
unique technologies, helps a company to develop a competitive edge in the
industry.
9. Extended Market Reach
Merging help companies to reach new markets and increase revenues and
earnings. Merger expands a company’s marketing and sales opportunities.
10. Financial Resources
Merger helps companies to acquire adequate financial resources. The combined
assets of the merged company will help to enhance the credit worthiness and
increase the bargaining power to obtain loans at a subsidised rate of interest.
4. Explain the steps in Merger and Acquisition.
Merger and acquisition is a time consuming process which involves complex
procedures. Companies have to fulfil different legal, official and financial formalities t
complete a merger/ acquisition transaction. The following are some of the important
steps in a typical merger and acquisition deal;
1. Formulating Appropriate Strategies
The acquiring company has to formulate suitable strategies to successfully
complete the merger and acquisition process. A clear understanding of the need
and objectives of merger, availability of funds, legal and technical issues are highly
essential for formulating effective strategies.
2. Setting up of Relevant Criteria
The acquiring company is required to establish suitable criteria for identifying and
selecting most suitable target companies for merger and acquisition. Poor criteria
may result in waste of time and resources. Financial returns, scope for growth and
expansion, competitive strength are some of the major factors in determining the
criteria for merger and acquisition.
3. Initial Survey
The acquiring company needs to conduct a preliminary survey to identify target
companies that can be considered for merger and acquisition. It has to prepare a
list of the target companies that meet the selection criteria.
4. Selection of the Target Company
The most suitable company for merger or acquisition is selected after conducting
a detailed examination of the companies included in the list prepared after the initial
survey. Initial discussion with the management of the selected target company is
started after the selection. The initial discussion helps to seek the willingness and
obtain consent of the target company for merger and acquisition.
5. Valuation of the Target Company
After obtaining consent from the target company, the acquiring company initiates
the valuation of its assets and liabilities. The valuation process helps to understand
the correct value of the target company which is the important factor in determining
the price of the merger and acquisition deal.
6. Negotiations
The acquiring company negotiates with the target company for arriving at a
reasonable price for the merger on the basis of the valuation. The final price of
merger is fixed at the end of the negotiation between the two companies.
7. M&A Due Diligence
Due diligence in merger and acquisition means an audit or investigation conducted
before making an investment. Due diligence begins when the acquiring company
and the target company agree for a deal of merger and acquisition. It facilitates an
in-depth analysis of all the aspects of the target company. It covers financial
position of the target company, assets and liabilities, legal issues and other
relevant matters.

5. Explain different types of valuation methods in merger and acquisition

In merger and acquisition deals, valuation refers to ascertaining the price that the
one company (purchasing company) has to pay for other company (selling company).
Valuation is usually made through assessment of stock price of the company and by
way of negotiations. The following are some of the important methods of valuation in
merger and acquisition transactions;
1. Discounted Cash Flow(DCF) Method
The discounted cash flow methods of valuation attempts to determine the value of
the company by computing the present value of cash flows over the life of the
company. The forecasted cash flows are discounted to a present value using the
company’s weighted average costs of capital. The DCF provides an estimation of
the company’s total value.
2. Comparative Ratios
Comparative ratio analysis helps to identify and quantify the strengths and
weakness of a company, evaluate its financial position, and understand the risks.
The most important ratios are as follows;
a. Price Earnings Ratios(PE Ratio)
The price-to-earnings(P/E) ratio means a company’s market price per share
divided by its earnings per share(EPS). This is a widely used method in the
valuation of merger and acquisition. It provides an indication of how much
investors are willing to pay for the earnings of a company. Firms with high
earnings and growth prospectus usually carry high PE ratios because these
companies are expected to give fair return to investors in the form of dividends
as well as increase in share price.
b. Enterprise-Value-to-Sales Ratio (EV Sales Ratio)
Enterprises value to sales is a financial ratio that examines the total value of
the company to its sales. This ratio is used in mergers and acquisitions to get
a basic estimate of the price a company has to pay to purchase another
company. A high ratio indicates an increase in future sales and a lower ratio
indicates unattractive future sales prospects of the company.
3. Replacement Cost Method
In Replacement Cost Method, cost of replacing the target company is calculated.
For this, the value of all the equipment and staffing costs are taken into
consideration. The purchasing company offers to buy all these from the target
company at the given cost. Replacement cost method is not suitable in the case of
service industry, where key assets are people and ideas which cannot be
accurately evaluated.
4. Book Value Method
In this method, the value of a company is calculated on the basis of the amount
that its shareholders would receive if the asset, liabilities and preferred stock of that
company were sold exactly at the amounts at which they are recorded in the books
of accounts. Book value method is suitable for firms that do not have intangible
assets. Assets such as intellectual property, brand image, and the competency of
the managers and officers are avoided in this valuation. The reliability book value
method depends on the quality of accounting practices followed by the company.
5. Stock Market Value Method
It is based on arriving at a value of a company according to the stock market. In
the context of companies, market value denotes the market capitalisation. The
stock market value of a company is determined by computing the current market
price of its shares. It beneficial when the shares of a company are actively traded
in the market.
6. Liquidation Value
Liquidation value is determined by calculating the amount of funds that would be
collected if all assets and liabilities of the target company were to be sold off. The
liquidation value varies on the basis of the time allowed to sell assets.
 6. Explain the Forms/Methods of Financing mergers.
On completion of the determination of the value of the target firm (the firm to be
purchased or acquired), the important issue is deciding method of financing the merger.
The direct and simple method of financing a merger deal is cash payment. The purchasing
company can retain the ownership of the target company in the case of financing through
cash payment. The following are some of the important forms of financing mergers;
1. Cash Offer
In cash offer, the value of a merger deal is settled by way of direct cash payment.
Cash payment facilitates easy and instant settlement of a merger deal. Dilution in
ownership can be avoided through cash offer. But the major drawback of cash offer is
that it may cause financial burden for the acquiring company.
2. Equity Shares Financing or Exchange of Shares
This is the popular form financing a merger or acquisition deal. In this form financing,
the buying company exchanges its stock for shares of the selling company. The
advantage of this financing is that both parties(buyer and seller) share the risks
equally.
3. Debt and Preference Share Financing
Another mode of financing merger and acquisition is the issue of fixed interest bearing
convertible debentures and convertible preference shares bearing a fixed rate of
dividend. It is beneficial to the selling company(company being acquired) because of
security of income along with an option of conversion into equity after a specific period.
The buying company is also benefited because it makes no dilution of earnings per
share as well as voting and controlling power of its shareholders.
4. Deferred Payment or Earn- Out Plan
In this method of financing only a part of the payment is made in the first phase either
in cash or securities. The balance amount is paid in future years from the earnings of
the buying company.
5. Leveraged buyout (LBO)
In leveraged buyout a merger deal is financed by using a significant amount of
borrowed money. The assets of the company being acquired are given as security for
the loans along with the assets of the acquiring company.
6. Hybrid
In the hybrid form of financing, a merger or acquisition transaction is financed through
a combination of cash and debt or of cash and stock of the purchasing company
7. Tender offer
In this method the acquiring company approaches the shareholders of the target
company directly and offers them an attractive price to sell their shares.
7. Distinguish between Merger and Takeover
The terms merger, takeover and acquisition are used interchangeably as a
process of combining two or more companies together. But there are thin lines of
differences between these terms. The major differences between merger and
takeover are described below;
Merger Takeover
1. It is process of combining two or 1. In takeover, one company takes over
more companies to expand their the other and rules all its business
business operations. In such operations. In this process one
situation, the deal gets finalised company overpowers the other
on friendly terms and all the company. A financially strong company
 companies share equal profits in establishes it power over the weak
the newly created entity. company and runs the business
operations in its name.
2. The companies in merger cease 2. The company that buys another
to exist and a new company is company continues its operations. But
formed. the target company may continue its
operation under the control of the buyer
company or cease to exist.
3. The shares of merging 3. The buyer company swallows the
companies are surrendered and business of the target company and its
new shares are issued afresh. shares are not traded again. But the
shares of the buyer company continue
to be traded in the market.
4. It is a combination of two or more 4. It is buying of an organisation by the
organisations. other.
5. There is a new formation in 5. There is no new formation in
merger. takeover.

8. Explain the defense strategies against hostile takeovers

Hostile takeover is a negative approach and it is considered as a threat or attack
against the sovereignty of a company. Therefore companies adopt different strategies
against hostile takeovers. Some of the important strategies are described below.
1. Golden Parachute – Golden parachute is an agreement between the company
and its top executives that they will be given huge benefits if the company is taken
over by another firm and they are terminated as result of the merger or takeover.
Benefits may include stock options, cash and compensation for termination.
2. Poison Pill Défense – The strategy of poison pill is to cause difficulties the deal
of a takeover. It attempts to make the shares unattractive to the acquiring firm. As
the name indicates, a poison pill is difficult to consume. There are many types of
poison pill strategies. The most important one is flip-in strategy. In this, the target
company allows its shareholders to purchase additional shares at a high discount.
3. Staggered Board Défense - Staggered board of directors means a board
comprising of different classes of directors who cannot be replaced at the same
time. The term of office of different directors are different as a result, it is not
possible for the acquiring company to replace the board of directors of the target
company immediately after the takeover.
4. White Knight/White Square Défense – In this strategy, the target company finds
a friendly company to purchase it so as to avoid the hostile takeover. The strategy
helps the target company to search and find better purchase terms, better
relationship and better prospectus.
5. Employee Stock Ownership Plan(ESOP)- In this plan, a company offers
ownership rights to its employees. ESOP discourages hostile takeovers because
a greater percentage of the company will likely be owned by employees who may
exercise their ownership rights in accordance with interests of the target company
rather than the interests of the acquiring company.
6. Supermajority – It is a condition which requires 70% to 90% voting rights for
merger or acquisition. This makes it more difficult for a company in the takeover
of the target company by buying sufficient stock for controlling interest.
7. People Pill: In this strategy – top executives and the employees threaten that they
will all leave the company if it is acquired. This only works if the employees
themselves are highly valuable and vital to the success of a company
 8. Crown jewels;-sells off its most attractive assets or crucial division to a friendly
third party. This prevents a company from a hostile takeover
9. Pac-man Défense-in this strategy ,the target company defends a hostile take over
by attempting purchase.

9. Reasons for failure of merger and acquisition

a. Differences in organisational cultures
Cultural differences between the organisations undermine the vigor of merger. It
is difficult for an organisation to integrate diverse cultures. The mismatch of culture
disturbs the working environment, which leads to the decline of the organisation.
b. wrong intention
Faulty intentions of the companies are the main reasons behind the failure of
mergers. Most of the companies prefer merger to influence the stock market.
sometimes companies go for mergers just to imitate others.
c. Poor relations
People may feel dissatisfied in the merged company because various reasons like
lack of confidence in the new management and poor relations. This ultimately
results in high employees turn over and great operational difficulty for the
company.
d. Excessive premium
In a competitive bidding situation a company may tend to pay more to acquire
another company. When the acquiring company fails to attain the synergies
required compensating the price ,the deal becomes a flop.
e. Lack of research
Merger and acquisition requires collection of numerous data and their [Link]
requires extensive research, mergers and acquisition without systematic study
may result in squandering of money another valuable resources.

15 MARKS QUESTIONS

10. Explain the types of merger

Merger refers to legal consideration of two or more companies into one
company. It is accomplished by one company purchasing the assets of another
company with cash or its securities or by purchasing the shares of another company
by issuing its stock to the shareholders of that company in exchange for their shares.
Elimination of unhealthy competition, increasing efficiency and diversification of
products and services are the major reasons of a merger strategy.
There are many types of mergers in the corporate scenario. The common types of
mergers are described below;

1. Conglomerate Merger
It is a strategic merger between companies that are entirely different or unrelated.
In a conglomerate merger, companies in different industries or operating in
different geographic areas are combined. Conglomerate mergers are of two types;
pure and mixed. The pure conglomerate merger is one where the merging
companies are doing businesses that are totally unrelated to each other.
2. Horizontal Merger
Horizontal merger is a popular type of merger that occurs between firms in the
same industry. It is a strategy for business consolidation between firms who
 operate in the same space as competitors offering the same products and
services. Horizontal merge is helpful in reducing the cut throat competition in a
market. This strategy is usually adopted in industries with small number of firms
and highest competition. For example, in 1994,Broke Bond India and Lipton India
merged and established Brooke Bond Lipton India Limited(BBLIL).
3. Vertical Merger
In this strategy, companies producing different goods or services for one specific
finished product merge together in an effort to reduce production and distribution
costs and increase efficiency for higher profits. The strategy of vertical merger is
same as in the case of vertical integration.
4. Market Extension Merger
The strategy of market extension merger refers to the merger between two
companies that deal in the same products but in separate markets. The goal of
this strategy is to get access to a bigger market. The strategy helps merging
companies gain big market share and a large customer base.
5. Product Extension Merger
This merger strategy is adopted to combine firms manufacturing different products
but manufacturing goods that fall in the same category. The product extension
merger allows the merging companies to group together their products and get
access to a bigger set of consumers.
6. Concentric Merger
Concentric merger is a combination of two or more firms which are related to each
other in terms of customer groups, functions or technology. Merge of a car
manufacturing firm and a tyre manufacturing firm is an example for concentric
merger.
7. Congeneric Merger
In congeneric merger, companies operate in the same or related industry but
offering different product lines merge. The two companies share similar
distribution channels. Merger of a beauty soap manufacturing firm and a face
cream manufacturing firm is an example for co-generic merger.
8. Statutory Merger
In a statutory merger, one of the merging companies continues to exist as a legal
entity, rather than being replaced by a new company. The surviving company
acquires the assets and liabilities of the merged company.
9. Cross Boarder Merger
In cross boarder merger, a company in one country merges with a company in a
foreign country. It is a merger between firms in different nations. A cross border
merger can be either inbound or outbound. In an inbound merger, a foreign
company merges with or acquires a domestic company.
10. Forward Boarder
In a forward merger, the target firm(selling company) merges directly into the
purchasing firm. It is also known as direct merger. In this method, the target
company ceases to exist and the two companies continue to operate as a single
entity in the name of the purchasing company.
11. Reverse Merger
In a reverse merger, a private company acquires the majority of the shares of a
public limited company, which is then combined with the purchasing firm(private
company). In a reverse merger, a private company becomes a public company.
12. Forward Triangular Merger
In a forward triangular merger, the purchasing company creates a wholly- owned
subsidiary for the purpose of merger. The selling firm in the forward triangular
 merger liquidates and merges with the acquiring subsidiary company. A forward
triangular merger is also known as triangular merger, subsidiary merger, forward
subsidiary merger and indirect merger.

13. Reverse Triangular Merger

In a reverse triangular merger, the purchasing company creates a wholly-owned
subsidiary for the purpose of merger as in the case of forward triangular merger.

11. Explain the recent trends in financial services

In recent years, there have been significant changes in the structure of the global
financial services industry. The following is an overview of the recent trends in financial
services;
a. Shadow Banking
Shadow banking is a situation in which non bank financial companies offer the
services of traditional commercial banks. These banking services provided by the
NBFC are not subject to any regulations unlike banking companies. Simply
shadow banking means unregulated banking services offered by the NBFC. Strict
banking regulations and a large number of investors who need huge funds for
investment are the major reasons for the growth of shadow banking.
b. Angel Funds
Angel funds refer to a money pool created by high net worth individuals or
companies for investing in business start ups. Funds required during the initial
phase of a business provided by a rich person or company in exchange for
convertible debt or ownership equity is termed as an angel fund. Angel investors
are Popularly known as angels, business angels informal investors and angel
funders.
c. Hedge Funds
The term hedge in financial market means an investment strategy that reduces
risk. Hedge funds are pooled funds just like mutual [Link] this case funds are
pooled from accredited investors like banks ,insurance companies and rich
individuals. Hedge funds offer a wide portfolio of investments ranging from
investments in currencies ,derivatives, stocks, real estates etc.
d. Financial Innovations(New Financial Instruments)
The present financial service sector is comprised of new types of financial
instruments and transactions. The new instruments include swaps, options,
futures, differential shares, asset backed securities, mortgage backed securities
and a variety of other financial instruments entered the financial service sector.
e. Cross Boarder Mergers and Acquisitions
Financial markets and institutions have become integrated within economies
and across countries. The financial service sector has witnessed consolidation
through cross boarder mergers and acquisitions in the banking and insurance
segments.

f. Multi-product Delivery
Financial institutions are now offering variety of products and services to
customers instead of focusing on any single line of service. Multiplicity of financial
 services under one roof is a recent trend in the financial service sector. For
example, a financial intermediary offering issue management, underwriting and
depository services.
g. Universal Banking
In universal banking, banks are allowed to conduct both banking and financial
market services such as underwriting and brokering of all kinds of securities. A
universal bank is both a commercial bank and an investment bank. For example,
a commercial bank offering mutual fund, insurance and venture capital services
along with its traditional banking services.
h. Increased Variety of Financial Intermediaries
Another major development in the financial services sector is the emergence
of new players and the increased diversity of players in the financial markets.
Earlier, some insurance and mutual fund companies dominated the financial
markets.
i. Variety of Financial Services
The financial service sector offers a wide variety of services to the investors
and companies. Deregulation of the financial markets and technological
advancements led to the development of new financial services.
j. Deregulation and Financial Market Liberalisation
Deregulation and reforms of the financial services sector happened across the
world. This resulted in increased entry and competition by private entities,
deregulation of interest rates, privatisation of state owned financial institutions and
reduced role of the government and public entities in financial services.
k. Technological Progress
Technological advancements have led to the innovations in the form of electric
data processing and transmission, automated teller machines, smart cards and
internet banking services. There have also been major changes in the stock
exchanges such as dematerialisation of instruments, replacement of floor trading
by computerised trading, electric settlement and clearing of transactions.
l. Financial Engineering
Another major development is financial engineering. It is the development and
creative application of financial technology for solving financial problems,
exploiting financial opportunities. Financial engineering is a multidisciplinary field
involving financial theory, the methods of engineering and the tools of
mathematics for finding out solutions for financial problems.
m. Financial Inclusion
Financial inclusion or inclusive finance is a remarkable trend in financial
services. It is the delivery of financial services at affordable costs to weaker
sections and low-income segments of the society.