Before I start of on this brief explanation of M&A, I would like you people to know that it’s my first attempt on writing of any kind. So please do bear with me for any mistakes. Comments and suggestions are welcome.
M&A are the order of the day in today’s world. Many companies in the recent past have acquired companies or have merged with one another to develop the quality of services they provide.
Very recently there was an acquisition by IT major Infosys, when they acquired a Swiss SAP consultancy firm called Lodestone for rupees 1930 crores. In the light of this I would like to give a run through the terms and other components which comprise mergers and acquisitions.
BASICS OF MERGERS AND ACQUISITIONS
Introduction on mergers and acquisition:
1. Mergers and acquisitions (M&A) include reconstruction , compromise, and arrangement as per sec 391-394 of companies’ act 1956.
2. Acquisition as per sec 395 of the companies act 1956.
3. Amalgamation as per sec 396 of the companies act 1956.
4. Reconstruction of sick industrial units as per sec 17 & 18(4) of the sick industries (special provision act) 1985.
5. Revival as per sec 72A of the income tax act of 1961.
6. But over n above all these the M&A has to be governed by the FEMA 2000 , income tax act 1961 , industrial (development and regulation act )1973 and any restrictions as per the SEBI act has to be adhered to.
7. When a company decides to restructure itself on its own it can be called as a scheme of reconstruction, arrangement or reorganization.
8. When two or more companies decide to blend into each other where one company wants to carry on the business of the blended undertaking then it is called as amalgamation.
9. Merger is referred to a scheme of restructuring where one company which is usually the smaller company is dissolved and absorbed by the bigger company to form a massive undertaking.
10. Merger within companies of the same industry is called as a horizontal merger whereas merger within companies of different industries is called as a vertical merger.
11. As we are aware of the fact that as per the INCOME TAX ACT OF 1961. There is a provision for a company to carry forward losses if any and this benefit can be only claimed by the loss making company. To avail such benefit a profit making company usually merges with the loss making company. This being the REVERSE MERGER.
12. Sometimes there is a merger between companies which are not at all related to each other either horizontally or vertically (i.e. producing similar goods and being in the same industry or having a relationship of a buyer and seller respectively), but they still decide to merge and form one flagship company with various other companies under it to take the advantage of the market conditions prevalent and to utilize the huge finances at their disposal. This type of merger is called as CONGLOMERATE MERGER.
13. CONGENERIC MERGERS: under this type of merger the acquiring company usually has some relation with the target company either through the usage of similar technology or even similar production processes or similar products. Under this merger the acquiring company tries to diversify or extend its reach in that market segment.
RATIONALE BEHIND MERGERS AND ACQUISITIONS
There are many reasons for mergers and acquisitions .some of those is listed below.
1. A company might opt for a merger to increase its market share.
2. To avail tax benefits available to loss making companies. And it is important to note that the acquiring company is not the only company gaining from merger. The target company can write off its losses against the profits of the acquiring company. The acquiring company can acquire a loss making company and reduce its tax liability.so it is a win- win situation for both the companies.
3. Merger can be opted for to increase the growth of the company. By acquiring an already established company the acquiring company avoids delay of acquiring building site, plant and machinery etc.
4. Mergers also result in access to idle funds. Sometimes the target company has idle funds but it lacks the required expertize to enter into other markets and diversify extensively. M&A helps to resolve this problem.
WHAT IS SYNERGY?
No company wishes to indulge in a merger without gains. This gain is called as a synergy.
Suppose company A wants to merge with company B. it will only go ahead with the scheme of merger when the value of the combined company is more than the individual value of the companies. To further elucidate on this point let’s see an example.
COMPANY A and COMPANY B decide to merge and form COMPANY AB
VALUE OF COMPANY A = Rupees 5 crores.
VALUE OF COMPANY B = Rupees 3 crores.
Now COMPANY A and COMPANY B will go ahead with the merger only when the value of the combined company is more than rupees 8 crores.(say 10 crores).Now the difference between the value of combined company AB and value of both company A and B is called as synergy which is (10-8)= 2 crores.
And of course there is a cost of acquisition which a company has to incur. So net gain after merger is going to be the amount left over after deducting any acquisition expenses.
An important point to note is that there is no hard and fast rule that companies should merge only when there are gains. M&A take place even when there is a potentiality for future gains if not any present gains.
AMALGAMATION
Accounting treatment for Amalgamation is of two types:
1. Purchase method
2. Pooling of interest method.
Purchase method is usually where the assets and liabilities of the transferor company is incorporated into the books of the transferee company at either their carrying amounts or a consideration is paid based on the fair value of the respective assets and liabilities.
Pooling of interests method is usually applicable when amalgamation is in the nature of merger where the assets and liabilities are taken over by the transferee company at book values.
Amalgamation is governed by AS-14.
ACQUISTION AND TAKEOVER
ACQUISTION: when a company purchases controlling interest in the share capital of another company it is called as an acquisition.
Acquisition can be either through:
1.Purchase of shares in the open market.
2.Purchase of new shares by private agreement.
3.An agreement with the majority holder of interest.
4.Acquisition of share capital of a company by issuing shares or paying cash.
5.Making a buyout offer to general body of shareholders.
When a company is acquiring another company it can either opt to merge both the companies and form a new company or it can run the acquired company as an independent entity and run it with a different management and different policies. The former being merger and the latter being called as a takeover.
TAKEOVER
Takeover can be of two types:
1.Friendly takeover
2.Hostile takeover.
When a company is acquired with the consent of the acquired company’s board of directors it is called as a friendly takeover, whereas a takeover conducted against the wishes of the board of directors of the acquired company is called as a hostile takeover.
REVERSE MERGER
Usually a bigger company decides to take over a smaller company. But in the case of a reverse merger it’s the other way round. So in this case it is usually not the merger of a sick and non- viable unit into the larger undertaking but it’s the other way around where the healthy undertaking is merged into the sick and non- viable unit.
TERMINOLOGIES IN TAKEOVER
DIVESTITURE: in divestiture the target company decides to cut out or branch out its business into separate business entities or subsidiaries so as to make it an unattractive avenue of business to the acquirer.
CROWN JEWELS: when the target company decides to employ divestiture it is said to selling off its crown jewels.
POISON PILL: poison pill is the term used when the acquiring company wants to look unattractive in the eyes of the potential bidder. What the acquiring company might do is it might issue convertible debentures in huge numbers which are convertible into equity shares at a future date. So when the acquiring company faces acquisition at a future date. It will look unattractive as the voting power would be substantially more and the task of the bidder to acquire the firm becomes all the more difficult.
POISON PUT: the target company decides to issue bonds and the holder of the bonds has an option to sell the bonds for higher amounts of cash which would result in an overwhelming amount of cash drainage. This would automatically make the target company unattractive.
GREEN MAIL: when a target company doesn’t want the acquirer to continue with the takeover it offers the shares of the company at a substantially higher price than the market price. This is called as a green mail.
WHITE KNIGHT: usually in a takeover especially in a hostile takeover there is a complete revamp of the management. To avoid all this the target company decides to merge with a friendly company so as to avoid the takeover.
CORPORATE RESTRUCTURING
Corporate restructuring can be done internally and externally. Internal corporate restructuring can be done through investment in new plant and machinery , total change in processes , divestment, sell offs, demergers and hiving off non core businesses. External corporate restructuring can be done through M&A, JV, alliances with other firms.
In other words, changes in assets, financial and ownership structure is called as restructuring
REASONS FOR DEMERGER
Demerger can be resorted to due to many reasons such as lack of funds and urgent need for liquid cash , lack of revenues from the said entity, inefficiency in management etc.
WAYS OF CARRYING OUT A DEMERGER
Sell off: in this case the company decides to sell out its product, asset or the subsidiary for a purchase consideration payable either in cash or securities.
Spin off: in this case, the business is created as a separate firm and this firm which has spun off runs as a separate entity with no change in management or the shareholders. Spin off doesn’t generate any cash flow for the parent firm but it has to just part away with the management(staff).
Split up: split up refers to breaking up the parent company into many smaller bits and pieces for efficient management and to increase the shareholders value.
For example, parent company A is split up into four separate companies called B,C,D,E after the split up the parent company ceases to exist.
CARVE OUTS: carve out is very similar to a spin off but the only difference between a spin off and carve out is that in spin off there is no inflow of cash whereas in a carve out some portion of the shares are sold in the open market resulting in the inflow of cash.
FINANCIAL RECONSTRUCTION
Financial reconstruction is popularly called as internal reconstruction of a company. This type of reconstruction is adopted when the company is on the verge of liquidation.
Internal reconstruction mainly takes place through the alteration of the assets and liabilities of the company. assets are usually revalued and liabilities are either paid off partly or waived off completely in some cases. The profit on account of revaluation of the assets and liabilities are used to write off any accumulated losses and other fictitious assets ( such as preliminary expenses and cost issue of shares and debentures ) the debenture holders are also either paid off partly or their debt is converted into equity. An important point to note is that the equity shareholders bear the maximum brunt of internal reconstruction as they have to forego almost all the accrued benefits. The equity shares are usually converted into shares of a lower value and debentures are converted into debentures having lower coupon rates (say for eg. 10% debentures converted into 5% debentures) similarly preference shareholders too forego their benefits.
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